Paul Winkler: Welcome to “The Investor Coaching Show.” I’m Paul Winkler, and we’re talking about money, investing, and the news of the day. I’m joined with Mr. Ira Work.
Ira Work: Good afternoon.
PW: Man, how are you doing?
IW: I am doing well.
PW: All right, so I know that you and I have been perusing the financial media and things out there, and we ran into the same exact article.
IW: Very interesting article.
PW: I mean, I think it’s a sign we ought to really talk about it. What do you think?
IW: Absolutely.
PW: Okay. So, it was about the exact age when you make your best financial decisions, and this to me is something near and dear to my heart because I’ve talked about it before.
Fluid Intelligence vs. Crystallized Intelligence
There was a really good book by Arthur Brooks and it was all about the two stages that we go through in life. We have the first stage, where you have fluid intelligence, which is what he called it. In essence, what happens is we are able to gather information, we’re able to solve problems, and we’re able to create things. I mean, you look at the best songs that people write they typically write in their 20s. After that, they don’t write anything that’s worth it. Songwriters out there, sorry. That’s just what they found in the research. If you write a really, really good song much later in life, it’s an accident.
IW: And sometimes all they write is one. You have all those one hit wonders.
PW: Oh yeah, yeah.
So, if we look at what happens later on in life, we have a crystallized intelligence, which is wisdom. And I think that’s a lot of what they were talking about here.
I think it’s interesting when we tend to make our best financial decisions. And what did you take out of it? I’ll have my takes on it, but what are some of the takes you had, Ira?
IW: Well, of the reasons why this struck me the most is that it seems that most of the clients who do come in to see us — or I should say, investors that come in to see us before they actually do become clients — are probably in their early- to late-50s. And they’ve been through enough financial advisors, they’ve gotten all the promises, they’ve seen all the glossy mountain charts with the past performance, and they’re wondering why their investments are not working out the way these investments they were sold did in the past.
PW: They’ve got some wisdom.
IW: Exactly.
PW: It’s like, how do you get good judgment? Have bad judgment.
IW: That’s why we tell our kids, learn from our mistakes, right?
Learn from our mistakes. You’re going to make enough on your own, but learn from ours.
So, it’s interesting that they’ve had three or four, sometimes five different advisors. Sometimes they have two or three advisors at the same time, and they’re coming to us because they’re unsure if they’re really doing what’s right?
PW: That’s funny, because I remember talking to an NFL football player. This guy was always on the All-Star team every single year, and he had two different financial advisors and I asked him, “So, what’s going on here?” And he goes, “Well, they’re watching each other.”
IW: Yeah. No, they’re not.
PW: No, they’re not.
IW: And I know they’re not.
PW: They’re co-signing each other’s BS so that they keep their jobs.
IW: Well, I don’t even know if they’ve co-signed. I don’t even think they’re talking to each other. I mean, I shared a few months back —
PW: Yeah. You were the smart guy of the two, that’s what the other financial advisor said.
IW: And then he wanted me to adjust our portfolios because of the bad decisions he was making with his portfolios for them.
PW: That’s just too ironic.
IW: So, some of the things that stuck out to me were how things change the older we get into our 50s.
Now I’m 62, and it’s amazing that a lot of these actually happened for me in my early 40s, but that’s why I am still in the business.
Car Loans
So, car loans, people usually wake up around 49-and-a-half-years-old and they start to realize, “Wait a second, maybe car loans are not such a good thing,” and car loans typically become minimized.
PW: My grandfather wore me out not to take a car loan when I was coming out of college. He just wore me out, and he was the patriarch. You don’t ignore the patriarch of the family. And you know what I did? I ignored him. But you know what? About four years later when I got it paid off, I never looked back and never did it again, because he was right.
IW: Okay. And I have a really good friend of mine, who about 25 years or so ago took out a car loan and a five-year note. The money went out of his check from work to this separate account, and every month the money got deposited into this separate account to pay the car loan. Well, at the end of five years the car was paid off, but he never thought, “Hey, let me stop doing this.”
PW: That means he set up a sinking fund to buy the next one?
IW: And that’s exactly what he did. He has not had a car loan in 20 years because every 10 to 12 years now he has enough money to just go and buy the car with cash.
PW: Right. Which is a sinking fund concept. That is what a big corporation will do for large ticket items.
They call it a sinking fund. It’s the same thing we ought to do.
IW: Now, I don’t necessarily have a problem with a car loan. I just bought a new car, and I did take out a loan.
PW: I noticed that. That car is fun waiting to happen.
IW: It’s a lot of fun. But I was fortunate to get a 0.9% interest rate. Now, when your grandfather said, “Don’t take a car loan,” interest rates were probably like they are today, 6–7%.
Car Loan Interest Rates
PW: Well, I often wonder though, do they push up the price of the car if you actually have a low interest rate, and that’s the way they make money?
IW: No, the car would’ve been the same price whether I wrote a check or whether I took the loan. Because I asked them, “Well, how much room is there for me to negotiate?” And she said, “None.” I bought the car, it’s a little Mazda Miata, so it’s not this high-end fancy supercar.
PW: So, what you’re saying is they’re using that to move cars. In my mind that makes some sense; if you’re having a hard time moving vehicles at the current prices, you might do something else to get them to move. If they don’t move, you end up with this big inventory. What do you do as a car company? You’ve got to get somebody to take these things off your hands if they’re built, and that’s basically what they’re doing, and they’re willing to take it on the chin in the financing a little bit. But it surprises me that they have no negotiation on the car whatsoever.
IW: No. I was watching the inventory. I had to wait about five or six weeks for the car to come in, and they literally had six Miatas in transit. One of them was mine, five of them said they were sold. So, they were sold before they even hit the lot.
PW: Okay. So, this particular car was a hot commodity, that makes more sense to me that you would have no negotiating room on something that’s a hot commodity.
IW: And also that 0.9% interest rate was only for three years. If it was a four or five or six year, the rates were between five and a half, to six and seven percent.
PW: But that makes no sense to me still, Ira, because if I am a car lending company, am I going to lend you money for three years at 0.9%? Or am I going to go down and put money in treasury bills backed by the government at 3.5%? I don’t see how that would do that. It seems there’s some bad business decision being made there.
IW: Well, that’s probably why you and I are not the CEO of Mazda.
PW: I’m just entirely too logical for this.
How Do They Make Profit?
IW: No. Because there’s actually, as you notice, profit built into their car, so they’re making the profit on the moving of the vehicle. There’s money to be made.
PW: But they’re not trying to move the thing fast. The thing is they’re not trying to move because they would’ve had it sold to somebody else, because they had those other cars. That’s just weird. Maybe that is why we’re in the position we’re in with corporations around the world right now, because maybe there’s not a lot of thinking going on in the boardrooms.
IW: Are you saying they’re losing money by selling the car to me for 0.9%?
PW: Well, they’re losing money on the financing, if they could find another buyer to pay cash.
IW: I don’t know, because when I bought my other last car, my Volkswagen Eos — again, not a big, fancy, high-performance car, not a luxury car — it was the same thing. I bought it at the MSRP and had 0% financing. So, I paid it out over five years. So, my point being really this, and this is really the more important part of it.
PW: They’re losing money. Go back to the point because they’re losing money and that’s their problem.
IW: I don’t think they’re losing money.
PW: Well, I mean they’re losing money on the financing. They could find somebody else to pay cash for it. If they wouldn’t have financed it at that rate, it would’ve been you anyway.
IW: Yeah, I would’ve bought the car because I told the girl, “Let’s run new credit and get me locked in, because I’m not going to be paying 5–7%. But if my money can make money staying invested, why would I not want to take a loan at 0.9%?
PW: I totally agree. It was a good decision for your part if they weren’t going to negotiate on price. Yeah, I agree. I just think it’s funny that they would make such a bad business decision, in my humble opinion. But anyway.
Home Equity Loans
IW: Well, anyway. At 55 and a half or almost 60 years old, people realized that financial mistakes are minimized by the age of 55.
PW: Yeah. I don’t think most people recognize that home equity loans are callable. So the bank, if they get panicked, they can call it, and then you’ve got to figure out some way to repay it. I don’t think most people recognize that. I haven’t seen one yet that it isn’t callable, let me put it that way.
IW: But how many banks have you ever seen call it?
PW: Well, I think there’s one very famous financial person, and that’s basically what happened to him. So home equity loans, I’m not a big fan of those things just because I think that it puts the person in danger.
And yes, I had this conversation with a banker not so long ago. I asked, “At what point would you call it?” And he says they’d have to be behind. And of course if they’re behind on the payments, then yeah, you could end up with a situation where it ends up being called.
Nobody ever thinks that they might be that person who ends up behind because of something unforeseen that happens.
But are they callable? Yeah. Can they be called? Absolutely. How often do they call? I don’t know the statistics on that, but I know that that is what causes them to be called. Because the bank doesn’t want your home. Well, I guess they might want your home, depending on how nice your home is, but they really don’t.
IW: No, they don’t. And that’s why for the most part it’s very … What’s the word I would want to use?
PW: It’s just rare that it happens?
IW: No, it’s why you’re getting such bargains in the foreclosure market, because all banks are really looking to do is recapture the loan amount. They don’t care.
PW: That’s right. That’s a really good point if you think about it. That is a really good reason, because you’re going to end up a statistic to them, and you don’t want to be in that position.
But home equity, people are paying off their home equity loan is what you’re saying there?
IW: Mm-hmm.
Credit Cards
They also realize: credit cards, late fees, etc. They pretty much wake up to those at about the age of 52.
PW: That late? Really?
IW: Yeah.
PW: That’s interesting to me.
IW: Another mistake that they make — and they start to wise up to this more so into their early 50s — is transferring a balance from one credit card to another credit card, with all these 0% interest rates being out there.
PW: Sure, I’ve seen people do it. Yeah.
IW: And there was another interesting article about that this past week. It made me realize my sister did the same thing. She made the same mistake. She refinanced her house, took money out of that to pay off the credit card debt, and ran her credit card debt back up.
And now she’s looking and realizing, “Well, I can’t refinance my house because I locked in at 4% rate, and now I’d have to do it at 5.5 or 6%.
She does have good credit. So, to take more money out and pay a higher interest rate — it’s just a scheme of, in my opinion, the credit card companies to raise, introduce these 0% loans, or 0% for a year, and then they jack it up to a mid-20% interest rate.
So, people get wise to that by the early- to mid-50s.
PW: Right. It’s interesting because you said in mid-50s is when they are actually the most financially savvy. I’ve noticed that too. People have been there, done that, they got the T-shirt.
It Takes Time
I’ve often said that for me the sweet spot is when somebody’s been burnt several times through financial annex. It took us years of being in the business to kind of figure out that, hey, you know what? This act of stock picking, market timing, moving money around, tactical asset allocation was a huge waste of time.
And that life insurance is not a good investment; it takes a while for people to kind of figure that out. Took a little while for us to even figure out that annuities were just a really bad idea for investors for a myriad of reasons.
And hence the thing is, why would we expect the clients to figure this out any faster? It takes a while because you go, “Well wait a minute, that person said I’d have this much money at this point in time, and I don’t have it.” And then all of a sudden they recognize that there’s a problem, and that usually ends up in about their mid-50s.
That’s usually when people call us and go, “Hey, you know what? I heard what you guys are doing.”
That’s when they end up in our offices.
IW: Well, for me it was doing what the industry taught me to do for 17 years. They didn’t tell me, “Hey, here’s two different ways that you can work with your clients. You can either use an academic approach, or you can use the gambling and speculating approach.”
PW: As much as we’d like to think that people learn from other people’s mistakes and that’s how they operate, I watch somebody else, and I go, “Wait a minute, what that person is doing isn’t working, so let me try something different.”
It is typically their own mistakes. I don’t know why we do that, but we think somehow that stuff happens to other people. I am going to be the exception. I am going to make this thing work. I am going to be able to determine when to move in, when to move out, watching markets.
Wisdom With Age
There was another article about that very topic as well, and somehow I am going to be the exception because I’m smarter. Maybe it’s the bravado of youth. I don’t know what it is.
IW: Well, I don’t know.
PW: This is something that’s been rolling around in my mind. I saw a statistic about younger people, and it’s really interesting. If you’re super young — let’s say you’re 11, 12 years old — kids are pretty happy, right?
IW: Mm-hmm.
PW: Fairly happy, carefree, everything’s great. Then you start to see happiness decline around 17, 18, 19, 20 years old, when they start to recognize that the world is on their shoulders to some extent.
And then they get into their 20s, and they start to realize that a lot of the things that they thought would happen — I would be able to do this, how I’d be able to change the world — they recognize that they can’t do that.
Then at 29 they reach this point of this hopeless feeling for many people that they reach at that particular point.
But an interesting thing happens. They get into their 30s and happiness starts to creep up and creep up and creep up and creep up, until we actually reach a greater level of happiness and stability and feeling of well-being in our late-40s, and in our early-50s.
We actually start to recognize that things are okay, but a lot of it is this getting rid of and getting past that point in our life where we think we’re going to change the world. And a lot of it’s because we don’t have the experience to realize that we don’t have that ability. And you know what? It’s not even that necessary.
It’s just learning how to live your life better yourself.
In your mid-50s, this is when you have all this wisdom, but it’s been from those past mistakes and it’s been through going through that period of time in your life when you were so frustrated and recognizing that you weren’t omnipotent, and you didn’t have all the answers, and you couldn’t change the world.
So, I think this is all interesting how it all culminates at that particular point in time.
Lost Potential for Wealth
IW: Yeah, I think that the sad part about that is the potential for wealth that is lost by the mistakes by people in the industry themselves not knowing what’s really out there for them to really truly help their clients.
Like I said, a lot of the stuff that we teach our clients when we hold workshops, a lot of it goes back to 1952. I mean, you’re talking about 70 years worth of data — Nobel Prize winning data in fact.
I worked for major firms. I worked for Shearson, Lehman Brothers, I worked for Smith Barney. I mean, I worked for major Wall Street houses, and they didn’t teach us this, to instill our clients with the science of investing to be able to be disciplined, and why that discipline will pay off, and how they can get market rates of return more consistently and more predictably than what they’re getting.
The DALBAR study shows that most investors underperform the market.
PW: And it’s not just by little, it’s by a huge, huge amount.
IW: No, it’s anywhere from 3–5%.
PW: And many times more. I’ve seen 7 and 8% in some cases over longer periods of time.
IW: When you look at a difference of just 3% for a 30-year period or even a 20-year period, you’re going to be talking about millions of dollars being lost.
PW: I think we’re still on this, because I like this topic, the exact age when you make your best financial decisions. We can talk a little bit about some of those decisions and what they might be that people make at older ages.
As you get older, I’ve seen people go the other direction. As they get older they become more confident. I’ve seen research on this as well.
People actually start to develop more confidence as they get older.
But actually what happens is their fluid intelligence wanes significantly after the age of 45. But then it really gets much lower unfortunately in your late-60s and 70s, and then all of a sudden people start to go back to making some bad decisions again and end up in a situation where they undo much of their good decision making from their mid-50s as a result of that.
IW: Yeah, I find that in the article they’re talking about a study which shows that most people in their 50s are underestimating their life expectancy by about 10 years. They’re expecting a life expectancy of about 76, when the average actuarial estimates are now that person living to 85 or 86.
So, if you’re not planning properly, then that can be a very, very big difference. One thing that was really interesting was it said at the age of 53, people have been dealing with financial markets for years and know how to look for the right financial products and minimize fees and payments. And I find that to be very interesting.
Cutting Corners
PW: That is interesting because so often that happens to be a mistake, because quite often what fund companies will do is they will cut corners in really bad ways.
For example, small company stock funds, value funds. When you’re using multifactor investing, that’s where the majority of assets typically end up is in smaller company funds and value funds because 96% of 20-year periods in that area, the market value does better than growth.
That is where the biggest impact can be if you’re cutting corners and doing what fund companies tend to do, which is that.
And indexing works super, super well, and that’s what they use in their marketing. Indexing works super, super well with large companies and large international, and that’s where you can cut the cost the most.
But the reality of it is that’s where you ought to have the smallest amount of money typically in an investment. I say “typically” because I’m thinking there might be an exception someplace, but compliance people want you to say typically instead of being absolute about anything.
Paralysis by Analysis
IW: So, here’s another interesting thing that it said in the article: People in their 50s have often experienced enough financial pain to make them more acutely aware of the need to weigh all financial alternatives carefully and avoid mistakes. You’re also at an age where you look at retirement savings and realize you’re running out of years to make it bigger.
PW: Right. Okay, so what’s your takeaway on that one? Because I definitely have a thought on that.
IW: Well, my thought is, in trying to analyze all the different investment alternatives, I think you end up with something called “paralysis by analysis.” I can’t make a decision because there’s so much information. In our workshops —
PW: A lot of people do nothing, yeah.
IW: We call it “emotional-based decisions.”
When you’re basing it on emotion, you’re typically going to chase something with a higher rate of return.
You look at what you have, you’re looking at how much you’re going to need for retirement.
When we sit down and work with clients, we’re asking, “What’s your social security? Do you have a pension? How much are you going to need from your investable assets to generate enough income to make up for the difference based upon what your current expenses are?”
So, people will often say to me, “Well, I’m willing to take more risks because I have to make up the shortfall of what I don’t have, or to catch up to where I’m going to need to be,” when that more often than not is the mistake.
PW: Yeah, exactly. And they go into individual stocks, and they start to move money around based on what they think is going to happen.
“Oh yeah, baby boomers are getting older.” This is one that was a few years back, and that really fell apart. But, “Baby boomers are getting older and they’re going to need more healthcare services, so I need more healthcare stocks.”
And I go, “Well, okay, so the companies that are doing healthcare, they’re going to want to pay more to use your money in the future because they’re actually going to have better businesses. They’ll have more money coming in, so they won’t actually need your money as much at all if they’ve got more money coming in.” That doesn’t make any sense.
And they went, “Oh yeah, I guess it doesn’t.” But yeah, “I’ve got to try to make up time. I didn’t save enough.”
Unfortunately it’s not always other people’s bad experiences that drive the boat, it’s our own bad decisions.
But then we learn from them and we can pass this stuff on. It’s called “generativity” actually, where we start to pass things on to the next generation. So, Ira, what else caught your attention here?
Investing
IW: So, this financial coach who often works with people who are in debt says she did most of these things right before her 50s. She avoided credit card debt, paid off car loans, and paid off a 30-year mortgage in 12 years.
But she didn’t invest as wisely as she could have. For example, she moved money in her retirement savings account out of growth funds and into fixed income funds.
“We would let market changes scare us into making changes we shouldn’t have,” says Miller, now 65. Miller says she and her husband could have made more money if they had left it in growth funds. Likewise, she invested in real rental properties, which she thought could be an easy source of income, but weren’t.
PW: Which is funny, because I just said that growth funds 96% of the time are not going to have the same return, that they actually lower returns. But the point being that she got into fixed income bonds, and often that’s the mistake I see people make.
Remember in the late ’70s, Ira, the article was talking about the death of equities?
IW: Oh yeah.
PW: Younger investors were pulling their money out of stocks, and only the older investors were actually staying in there. So, this is nothing new that we figured out that older people tend to have a little bit more wisdom. But in general, that’s just me nitpicking about what she could have done putting money more in growth stocks. And maybe she needs to learn that lesson too, that it’s not the best to go and invest in just growth stocks.
Growth Companies and Fixed-Income Investments
You may be wondering, “Paul, what’s the problem with that?” Growth companies, folks, are companies that have grown, past tense. Those are companies that are growing rapidly, have grown, and when we look at historical returns, if we even look at let’s say small growth companies, you’d think, “Wow, they’re small and they’re growth companies and they’re great companies. Boy, that’s where you should have the maximum return.”
If you go back a 100 years and look at the data, and not just in recent years, but going back even further than that because this stuff doesn’t change — if you look at the cost of capital concept, it just makes sense.
People have to pay to use your money no matter what period in history we’re talking about. Small growth companies would have some of the lowest returns of any area of the market. And yet we hear the term growth and we don’t recognize that what we’re hearing is a marketing term, and we’re getting sucked in by marketing.
But anyway, she was saying that she kind of learned the lesson about fixed income, and she got out of debt early, which is smart. But then when she started investing, she started looking at what she saw to be safe, fixed-income investments and didn’t recognize until later on that safety is an illusion, as Helen Keller would’ve put it.
IW:
The reality is most people don’t even realize that fixed income investments are not safe investments.
And I don’t care where it is. I don’t care if it’s a CD at the bank, I don’t care if it’s a savings account, or the credit union. Because the value of the investment itself — the bond, the note, the treasury bill — those are going to fluctuate in value based upon what’s going on with current interest rates.
That’s the reason why last year we saw the value of bond funds decrease. As interest rates went up, you didn’t need to invest as much money to get the same income as a lower rate fixed-income investment.
PW: Yeah. Tell Silicon Valley that they’re safe.
IW: So, as a result of that, people are looking at their funds with the stock market dropping, and interest rates are going up, causing the underlying value of those securities to drop. And now both the star funds and the fixed-income funds are both dropping and they’re thinking, “Well, these are supposed to be safe.”
No, they provide a relatively lower volatility fluctuation up and down, depending upon the maturity. Now, that’s another thing to be looking at. Depending upon the maturity if it’s long-term, they could be just as volatile as star funds.
Which is why we tend to recommend very short term, two, three, or four years in maturity. It doesn’t mean we won’t have five or six, and it doesn’t mean we don’t have six months to a year, but we tend to have funds or recommend funds that are shorter in maturity for a little bit more stability and less fluctuation.
But when interest rates are going up, fixed-income investments will tend to drop.
Look at History
So, I think it’s just an illusion because there is a lack of good education for investors.
Me being in the business, if it took me 17 years before I finally discovered there was a way to invest based upon science, how much more difficult is it going to be for somebody who goes to another job, whether it’s fixing plumbing or electrical systems in homes or buildings or the educator who works with our children to teach them what they’re going to need to go to either college or into the workforce. The police officer, the firefighter, the nurse. How much more difficult is it going to be for them to find this information?
PW: For sure. Now, you said something earlier, and I just want to come back to it because as you were talking about the safety of fixed-income investments and how they’re not safe, it made me think: If we look back through history and we look at large US stocks, if we talk about the area of the market that historically, a 100 years ago, would’ve had one of the lower returns, but much, much better than fixed income — 10% every 30-year period in all of history — the S&P 500 had a rate of return of 10% plus or minus one or so.
Small companies would be higher, value would be higher, small valued would certainly be higher, international small companies and international value companies, so on, for the data that we have going back to 1970, had historically higher returns. Now, let’s take that lower number because we have some really good data on that S&P 500 and go back to 1926. Okay, so what’s the rate of return of the S&P 500 after inflation?
IW: It’s about 6.5 or 7%.
The Rule of 72
PW: Yeah, exactly. So, about 7%. So, the rule of 72: 72 divided by your interest rate is going to tell you how long it’s going to take for money to double.
Now, let’s take a different take on safety. Let’s say I had $100,000 and I put it in, and let’s just say that there is no additional money to keep this simple. Let’s keep it simple. So, we have one doubling period after 10 years, so the $100,000 becomes $200,000. We got another doubling period, another 10 years, and it becomes $400,000. And then another doubling period after. So, at the end of 30 years you have $800,000. So, $100,000 becomes $800,000 after inflation in my example.
So, now what if we’re talking about fixed-income investments and the rate of return of T-bills after inflation is like 0.3.
So, we still have $100,000. What gives me more safety in this particular case of not running out of money, being 30 years down the road with $800,000 or $100? It’s just a different way of looking at it.
But if we look at that, and of course we look at stocks historically, and we see that protection against inflation; we don’t see it with fixed-income investments, and we need protection against inflation no matter what because the dollar has gone down and continues to go down in value because the amount of money supply keeps increasing.
So, you hear people say, “Hey, you need to protect yourself against the dollar.”
These gold commercials crack me up. I was watching another one last night, “This is what we got to do at such and such capital. Did you know that the founding fathers didn’t trust printed money?” is what he’s saying in the commercial. You heard this commercial, right?
IW: Oh, I have.
PW: You know what I’m talking about?
IW: Yes, I do.
PW: “So, what we want to do at such and such capital, we want to sell you gold in exchange for your dollars that the founding fathers didn’t trust.” It’s just goofy. It makes me nuts.
IW: But one thing is always a concern of mine, because I have clients who come back to me and say, “Well, based on the rule of 72, the money should double.” Now, yes, it should, if you had a consistent rate of return.
But you can be right totally on track, get to year nine and your money, if it just goes one more year in the market at that 7%, it’s going to double by the next year. But then you can have a year where you’re 20% down.
The rule of 72 has to be taken very carefully when you use the stock market returns.
PW: Right, right. That’s why I used a 30-year period.
IW: And I see this all the time, I have a lot of clients who do come to me and say, “Hey, well based upon the rule of 72, I should have that money by next year, or in 10 years. If I’m looking to retire and I have $150,000, and I have two 10-year periods,” like your example just a moment ago. That $150,000 becomes $300,000, that $300,000 becomes $600,000. I should be able to retire on that because I have a pension and social security.”
But it doesn’t necessarily work that smoothly.
S&P 500 and Diversification
PW: Ira’s making a point. I was talking about the rule of 72. If you take 72 divided by the rate of return of an investment, that tells you how long it takes for money to double. That works fairly well up to about 12% return. Above that it starts to fall apart a bit.
But if you have a 10% return, 72 divided by 10 is 7.2, so it takes about 7.2 years for money to double. If we take the rate of return 7%, it’s 72 divided by seven, meaning it takes about 10 years, so on and so forth. So, it works fairly well.
Now, the point that Ira was making is that it’s not consistent that it will be that. If you look at like, let’s say 2000–2009 in the S&P 500, there’s no doubling at all. I mean, you were basically flat that whole period of time, with actually a bit of a negative.
This is why we diversify.
You put all your money in the S&P 500, and you can go long periods of time with no return whatsoever. Jumping forward a couple of years to 2004 and look at a 10-year period, now you’re at 5.6%. Remember it’s long-term 7%, so it’s still below the long-term return right there.
Then you fast-forward a couple of years to 2009, over the next 10 years, it’s 11%. So, actually it was faster. It wasn’t 7%, it was 11% after inflation in that period of time. And then 2010–2019, there was about 12%. So, money doubled every six years in that period of time. And then the next, 2011, and then 2012–2021, it was 14%, so money doubled even faster in that period of time. Because the rule of 72, take 72 divided by 14, and now we’re what? About four or five years for money to double in that period of time.
Okay, so you look at that and you say, well, wait a minute, the rule of 72, sometimes it didn’t double at all, and sometimes it doubled much faster. Now, when looking at longer periods of time, if we bring this out 30 years, you’ll see that ‘74, 30 years ago, hence 7.1%. The next period is 8.9%, a little bit higher, 8.1%, 7.9%, 8.5%, 6.9%, 7.5%, 7.37%, 7%. I’m looking at rolling 30-year periods after inflation for the S&P 500, and you notice that they were all in a much, much more narrow range.
So, when we look at that, that’s a really good point. Number one, it tells us that’s why we diversify more, and you don’t know when those big returns are going to come in; it’s unpredictable. You have that data from 1963–2004 showing that 96% of returns occurred in 0.9% of trading days. Try to figure out which days and when those big jumps will occur, you don’t know. So yeah, that’s really good stuff right there.
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