« Can you trade options in an IRA? | Main | The Performance Paradox - Fear - (Part 1) »

December 19, 2007

Why Bonds Won't Cut It

Some of you know I went to the University of Colorado (go Buffs!), also known as CU, also known as "Ski-U". Freshman year, my ski days were in the triple digits, if that gives you any indication - and no, I wasn't on the ski team.

 

Back then, we could buy books of coupons good for discounts on food, lodging and lift passes at ski areas all over the state. At the time, I could ski the top notch areas, like Aspen or Vail, for less than $20 a day.

 

I started thinking about that last week while Jim and I were in Las Vegas. While we were there, I read an article that said one-day lift passes, at many of the big ski areas, are now approaching $100 - a day! This is why I believe inflation, not market losses, is the biggest threat to your wealth.

 

Since I was in college, back in the early 80's, the price of a lift ticket has gone up an average of about 6.5% per year. That is faster than the rate of inflation overall, which averages between 3.5% and 4% per year.

 

Now, imagine I was a college student living on a fixed income of $100 a month. Back in 1985, I was living large on $100 - I could ski anywhere, for an entire weekend, on less than that - gas, food and lodging included. (Granted, I wasn't staying at the Four Seasons, but still!)

 

Today, assuming my income wasn't being adjusted by at least the rate of inflation, I can barely afford a one-day lift pass. My income is unchanged, but my purchasing power is sharply diminished.

 

A friend of mine asked me why would anyone invest in stocks? She had all of her money in bonds paying 5%. There was almost no risk, and the income produced was enough to pay all of her bills … today! She thought, as long as she only took out the 5% each year, she could live indefinitely on that money. What she wasn't accounting for was … you guessed it, inflation.

 

So, let's see how much you really need to stay ahead of the inflation boogey monster. Suppose you spend 4% of the value of your portfolio each year, after tax. Assume a 25% marginal tax bracket and a 3.5% average annual rate of inflation. You would need a gross average annualized return of 10% ((4 + 3.5) / (1-.25)).

 

Over the last ten years, the U.S. bond market total return has been approximately 5.5%. Clearly a bond portfolio falls woefully short. Unless you are Warren Buffett - in other words, a billionaire with a reasonably modest standard of living - you are going to have generate something significantly higher than bond market returns in order to sustain a reasonable standard of living.

 

So, while we would all like to stop worrying about the markets ups and downs and retreat to the so-called "safe havens" offered by lower return investments, our reality requires us to do two things: 1) Move UP the risk-reward continuum toward higher risk - higher return investments sufficient to support a reasonable standard of living; and 2) Avoid the mistakes that cause investor return to be lower than investment return.

 

Not sure how to do that? Then I would invite you to one of our Snider Investment Method™ information sessions. 'Nuff said!

 

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make 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. 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. All investments are subject to risk including possible loss of principal.

 

Posted by Kim Snider on December 19, 2007 | Permalink