The 7% bet ... is it prudent now?
This blog post was last updated the end of 2009, but the basic strategy is still very relevant. The market continues to reach new highs in stock prices. If you've invested in stocks, in retirement accounts or otherwise, you should be ahead nicely year over
year. But what now? Perhaps employing a "safe money" strategy is
prudent now with a portion of your money. Read on.
Investing has always been a trade-off. Making choices with your money involves
weighing the potential risk and rewards to determine the best course of action
to achieve your desired goal. So, in a way, investing is akin to odds-making.
In America, wagering is never a sure thing, but you can weigh the odds by using
past data. This is fairly easy to determine in the stock market since reliable
statistics and performance are readily available for past sessions going back
at least to before the Great Depression, or about 1925.
I thought it timely to undertake this market study now, as the stock market has
fallen about 20% since its high last October (2007). I'm using this 7% figure
to compare stock price performance vs. a hypothetical 7% rate of return, what's
available in a fixed index annuity. The answer sought: is it generally better
to accept the market risk of stocks (gaining above in any one year/decade, and
also losing money), or to bet with the a less risky maximum 7% annual return
with no risk of loss when the stock market is down for any year. To get
started, I took the annual Standard & Poor’s 500 Index* and compared this
with a fixed index annuity that would credit you interest annually based on the
performance of the S&P 500 Index with a cap of 7%. The cap is the maximum
you could earn in any year. The floor is zero in the down years. You would
never lose money in a down year with your principal. Dividends were not
considered for ease of calculations. Eight decades of data were used, starting
in 1930, and ending in 2009. This covered all of my available data, and
represented co-incidentally about the lifetime of an investor, 80 years.
The data presents itself as follows:
1930’s Stock market lost 41%, the 7% strategy gained 31%
1940’s Stock market gained 34%, the 7% strategy gained 40%
1950’s Stock market gained 257%, the 7% strategy gained 65%
1960’s Stock market gained 53%, the 7% strategy gained 50%
1970’s Stock market gained 17%, the 7% strategy gained 49%
1980’s Stock market gained 227%, the 7% strategy gained 66%
1990’s Stock market gained 315%, the 7% strategy gained 68%
2000’s Stock market lost 24%, the 7% strategy gained 40%
Well, the tally is pretty easy to figure visually: being a long term investor
in the stock market paid off more than the 7% annuity plan, but you needed a
strong stomach to stay in during all the bad markets periods (25 years were
down years). Using the 7% maximum gain in any one year, and all down years
counted as zeros, you would have beaten the buy and hold market one-half the
time by decade, ‘30’s, ‘40’s, ‘70’s, and ‘00’s. The other 4 decades your stock
portfolio would have bested the 7% strategy. Note also that all decades were winners
for the stock market, except the '30's and '00's just completed. But - the 7%
plan beat the market in the '40's and '70's due to truly bad years that reduced
the average gains over the 10 year decade.
Taken all together, you earned about 2X more by following the market as a buy
and hold investor. You may say, "that’s all history now, what do I do
today?" My reply; if you are 10-15 years to retirement, keep ¾ of your
money in the market, and ¼ in the 7% plan. If you are older and closer to
retirement, keep less with Mr. Market, and more in the safer 7% plan. With the
recent stock and credit market turmoil, you should look at your money
allocations to determine your risks as you inch closer to retirement.
If you can't eat or sleep well, you probably need to consider changes. Call me
and I can help you with that.
Barry Unterbrink, C.R.P.C.
* source Ibbotson & Associates SBBI yearbook