Why trying to beat the stock market is a poor goal.
Many people place too much importance on trying to beat the stock market. How much of our society compares everything about investing to the Standard & Poor’s 500 index? When you beat the market you’re happy and sad when you underperform. Why is this? Are your goals really tied to the stock market? This perspective is flawed from the beginning. For example, would you have been happy at the end of 2008 if your investment accounts were down 35%? The market, as indicated by the S&P 500, was down 38.5%. You beat the market by 3 1/2%! Somehow, I don’t think you or your spouse would think this was great news. That is why “beating the market” should not be your goal.
The true purpose of investing is to help you accomplish your goals. The rate of return you need to achieve should be independent of stock market returns. The market returns only enable you to see if your goals are realistic. For example the need to send children off to college, or purchase a home, or obtain financial freedom, using the S&P 500 as a benchmark has no importance to your personal goals. When you focus solely on the returns of the market you miss the true purpose of investing – reaching your personal goals.
Most people want financial security. They want the freedom that comes along with having money. It can buy you a different lifestyle. It can buy you more time to volunteer or help others. It can allow you more resources to send to ministries, charities, and organizations important to you. It can buy you more, and more but what good is financial security without significant meaning in your life? People NEED other people to share life and money with. Our goals should also reflect ways to help the less fortunate and finding places to spend meaningful time. If life on earth is just about your personal pleasure you’ll never have enough. Shouldn’t our lives focus more on making the world better?
Detours – financial obstacles to keep you from your goals
Growing up, I watched the hardest working man I knew, my grandfather, lose his entire life savings. Here he was working three jobs to put food on the table for his wife and seven children. He would work any job that he could find just to help this family out. He did this for over 30 years before he retired with significant health problems. Despite his lack of investment knowledge, he was a diligent saver and managed to scrape together over $500,000 at retirement.
What was more money than he ever knew what to do with turned out to be less than enough. His first obstacle was taxes. Much of his money was in IRAs which he had to pay taxes anytime he withdrew money. He also had some CDs which were taxed every single year. When he invested money he paid income taxes on the interest he earned. He also paid income taxes and capital gains on a few shares of stock he owned on the dividends and profits he earned.
Taxes eat away at your returns
As of January 2009 tax rates in America stand as high as:
- 35% for federal income taxes (when you earn income)
- 15% for capital gains taxes (when you sell assets at a profit)
- 45% for estate taxes (when you die)
- 45% for gift taxes (when you give property away)
- 7.25% for state sales taxes
- 2.8% for local property taxes
Source: Internal Revenue Source & U.S. Census Bureau
The Second Villain
My grandfather watched as his purchasing power slowly eroded. As his nest egg grew he found his dollars bought less and less. Inflation which is measured by the consumer price index (CPI) has been remarkably consistent at 3.2% since 1926 (Source Bureau of Labor Statistics). This means each year, goods and services generally increase by 3.2% in price. So every dollar is worth 96.8 cents at the end of each year. Some years inflation is higher and some years lower but averages 3.2% per year.
So when my grandfather thought he was investing in a risk-free investment through his certificate of deposit (CD), he assumed he was making a wise decision. After all why expose his life savings to risk? What he failed to calculate is that CDs historically pay 3.1% interest annually (source: Bankrate.com). So for every hundred thousand dollars he put in a CD, he earned $3,100 in interest. Yet after paying for taxes (let’s assume 30%), he was left with $2,170 or a 2.17% rate of return. However after inflation of 3.2%, he is left with an annual return of -1.03%. Typically the only true guarantee of a CD is that it will not outpace inflation and taxes. Unfortunately, my grandfather learned the hard way!
Don’t become a victim
You may say losing 1% per year is better than losing 38% in one-year investing in the stock market. You’re right: that one-year you would have been better off in a CD versus the stock market. However if you lose 1% per year for 25 years ,you lost more than one quarter of your nest egg before you even spent a dime.
David came to see me in 2002. He had been burned by the stock market. He had retired in 1999 with over $1 million and placed the majority of his investments in technology stocks. He figured he could withdraw $50,000 a year for the rest of his life. At 5% withdrawal rate how could he go wrong? David invested too aggressively and his million Dollar portfolio soon became a $500,000 portfolio during the technology collapse from 2000-2003. Still, he kept taking his $50,000 per year withdrawal (now a 10% withdrawal rate). It didn’t take long to spot David’s problem but how could you fix it? The solution was an easy. He had to either decrease his withdrawal rate, reallocate his assets, or a combination of the two.
Sometimes there are no easy solutions. Yet being too conservative can be just as dangerous as being too aggressive. My grandfather saw the dangers of being too conservative. David saw the dangers of being too aggressive. Finding the appropriate middle road is often the key solution. For most people gone are the days of pensions, possibly Social Security, and many corporate benefit packages. There is a greater need today to rely on self directed investment strategies to balance risk and achieve your goals.
I admit I am deeply saddened by the number of people putting their life savings into bank CDs thinking it’s the “safe thing” to do. They avoid the stock market like the plague because they fear losing money. Yet the sad reality is the only guarantee they’re getting with that CD is a guarantee that they lose more and more purchasing power the longer they own the CD. What looks like a safe, predictable, stable rate of return is disguised as a means to outlive their savings and go broke!
Don’t go broke! Start learning more about investing your portfolio today! For a FREE report on screening your investments and building a winning portfolio, go to http://www.FaithBasedInvestor.com