A man is
lying in his hospital bed, surrounded by friends and family, reflecting on his
recent near death experience. "I
always thought it'd be the ulcer that killed me. I did everything the doctors
told me. I drank the cream, ate the butter, drank the milk. And now I have a
heart attack!" This was a scene from a new original series on AMC, called
"Mad Men", set on Madison Avenue in 1960.
It is also a
scene playing itself out in the portfolios of millions of Americans. Like Don
Draper's boss in Mad Men, many of us are fighting the wrong dragon - and
killing ourselves in the process.
At each
speaking engagement I do, I ask my audience, "When thinking about your
investments, what worries you most?" One of the first answers offered is
always losing money. Capital preservation is our ulcer. Inflation is our heart
attack.
Think about
the average Baby Boomer - someone born around 1952. For many of you, that won't
be too tough. You are the average Baby Boomer. Assuming your parents were 25
when you were born, your parents would have been born right around 1927. How do
you think that shaped the messages you got about money, and in particular about
investing? How do those messages affect you today?
The dominant
financial experience in the lives of most of our parents, and certainly our
parents' parents, was the Stock Market Crash and ensuing Great Depression. As a
result, Baby Boomers were imprinted with certain ideas about money, almost from
birth: Don't put your money at risk, pay off your home, stock market losses are
ruinous.
It is not
just investors who are indoctrinated with this belief system. The ranks of
financial advisors, financial journalists and government regulators are
populated by this same demographic cohort, with the same belief system,
stemming from the same seminal event.
As a result,
as we accumulate assets, we become focused - obsessed in some cases - on
avoiding capital losses. So, as we age, we put more and more of our money into
fixed income securities like bonds. If capital preservation is the ulcer, fixed
income portfolios paying 5% or 6% are the cream.
"How so", you ask? The first
thing you have to understand is the fact from which all your investment
decisions must emanate, assuming your objective is to someday be able to live
off the proceeds of your portfolio, is your life expectancy.
The average
retirement age for all Americans retiring in the year 2007 is 62. So let's
consider the case of the average couple retiring this year. They are both 62
years old and non-smokers. I want you to take a guess as to the age at which
the second death will occur. In other words, both are 62 years old today.
According to the actuarial mortality tables, how old will the latter to die be,
when he or she passes away?
Jot the
number down or just fix it in your mind. Got it?
If you would
like to dig for the answer, or verify the answer I am about to give, go to your
insurance agent and ask to see the mortality tables for the joint life
expectancy of a 62 year old man and a 62 year old woman who don't smoke. They
will confirm for you the answer is 92 years old. Their joint life expectancy is
30 years.
This is the
good news bad news joke. We are living longer, but that longevity is also one
of our greatest risks.
Now I want
you to consider this. In 1988, I was fresh out of college and I made $18,000 a
year. I was single. I had my own one bedroom apartment in a reasonably nice
apartment complex. I had a new Ford Probe Turbo, on which I made monthly
payments. I paid my insurance and gas. I could afford to eat out, go out at
night with friends and take a couple of vacations a year. I could do all that
on $18,000 a year. Granted, I didn't save anything, but my lifestyle was pretty
comfortable.
So imagine
one of my grade school teachers who retired, in 1977, with a pension of $20,000
a year. They were probably able to live pretty comfortably too - for awhile.
After all, the median income in 1977 was $13,572. In 1977, a gallon of regular gas cost $0.62.
You could buy a Porsche 924 for $9395! The median price for a new home was
$54,200.
But fast
forward thirty years to 2007. How well do you think my grade school teacher is
doing on that $20,000 a year pension now? Even with a Social Security check and
a paid for house, I can promise you, her monthly income doesn't go far enough.
So here is
where our inherited belief system clashes with our reality. The cost of living
rises, in the United States, an average of 3.5% per year. That does not take
into account health care, which is rising at least twice that rate. If you hold
a portfolio which returns 6% a year, for example, your real rate of return, or
the return left after inflation, is only 2.5%. This is not enough to sustain
any reasonable standard of living over a period which will likely span 30 years
of retirement.
The only way
to sustain a reasonable standard of living over that long of a time period is
to earn a real rate of return significantly higher than that paid by bonds. In
short, your long-term standard of living is directly correlated to the
percentage of your assets you place in what has traditionally been thought of
as the riskier asset classes, like stocks.
And therein
lies the conundrum. In order to live comfortably, you must do the thing that
you fear, which is put your capital at risk - because profit is the reward for risk. Without risk, there is no risk
premium. And you must earn the risk premium in order to be able to live when
you no longer have a paycheck.
That is the
bad news. Here is the good news. In spite of what you may think, in spite of
what your gut might tell you, and in spite of the belief system passed on to
you by your parents, there is, effectively, zero risk in the stock market for
the long term investor holding a diversified portfolio. Market risk only exists
in the short term.
To that end,
we have to stop thinking of our investment time horizon as our retirement date.
Our investment time horizon is as long as we will live. For almost everyone
reading this, we are talking a minimum of twenty years. For most of you, much
longer.
I am 44. For
planning purposes, I assume my investment time horizon, for example, stretches
to the age of 102. In other words, my investment time horizon is 58 years. If I
plan to hold an equity based portfolio for that long, what risk do I have? Not
much.
Will I
experience temporary declines in my portfolio value? Of course. Markets are
cyclical. They go up and down. But at the end of 58 years, how likely is it
that my investment will not have grown at a rate that exceeds the total return
on bonds? As my grandmother used to say, "Nothing's impossible, just
highly improbable."
Therefore,
your choices are really quite simple. In order that you not run out of money,
or at least purchasing power, you must commit a substantial portion of your
assets to equities and keep them there for the long term - through the ups and
downs - all of the panic buying and selling. The only way to make the required
return is to always be in the stock market. Not market timing. Not stock
picking. Holding a portfolio of America's greatest companies over long periods
of time.
For most of
you, that is not easy. It will never be easy. It goes against programming
imparted to you almost at birth. But you have to do it anyway. To do otherwise
is to guarantee a heart attack by treating the ulcer.
Kim Snider Financial Communications makes no
representation that the information and opinions expressed are accurate,
complete or current. The opinions expressed should not be construed as
financial, legal, tax, or other advice and are provided for informational
purposes only. Diversification does not
ensure a profit or protect against loss of in a declining market. All
investments are subject to risk, including possible loss of principal. Call
866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider
Investment Method, investment objectives, risks, suitability and other
information. Please read and consider carefully before investing.
