Wednesday, January 13, 2010

“One two buckle my shoe”

As a small child we learned math using rhymes.

As I was looking at my client returns for 2009, which in almost all cases beat our target return, I realized that some of the performance results I was hearing about were false or misleading at the best. Imagine that some people couldn’t figure out their real returns.

In 2008, you remember that year; the return on the S&P 500 was -40%. In 2009 the return was + 24%. Some people combined the two returns and came up with a minus 17% return for the two years. The math looks simple enough, minus 40 and plus 24 equals minus 17%. The problem is that isn’t how it works in the markets. Let me show you the real math.

Let’s say that on January 2, 2008, you had $100,000 invested in the S&P 500. At year-end, with the market down 40%, your $100,000 was worth $60,000. You decided to stay with your index investment throughout 2009 and as a result of staying you earned 24% on the $60,000 in 2009. Your $60,000 was now worth $74,400. You were sill down $25,600 or 25.6% not the aforementioned 17%.

So what return would you have needed in 2009 to get back to your $100,000? If I have $60,000 and I wanted $100,000 then the math says I needed roughly a 67% return in 2009 to get back to even. Here is the problem I have, the math is correct but what the math is talking about affects people’s lives.

I have been saying for several years that the recovery in the US economy will be more like the economy of Japan than post World War II American recovery. Recently I have seen several financial writers refer to the first decade of the 21st century as the lost decade for stocks and investors. The return on the S&P 500 for the last 10 years has averaged a minus 2.4% annual return. It seems to me very difficult to build for retirement when the investments that are supposed to give you growth had the worst 10 years of performance in decades.

I have several clients who have reached the age at which they must start taking distributions from their retirement plans. The big unknown is how long they will live and need income. Understanding what rate of return you need to earn to keep the money growing and meet the government requirement for distributions is simple math. Earning that return is not as simple.

A person retiring today needs at least a 6% return on his money to meet the distribution requirements of the government and continue to build capital. With the true return for the last two years being off 25.6% and needing 6% to meet the needs you are “three, four shut the door”, behind! This decline of 25.6% divided by the target of 6% says that you are over 4 years behind in the return you need to have your money last as long as you.

People are waiting for the Federal Reserve to start raising interest rates so they can have a chance of making it through retirement. You who are readers of this Blog know my thoughts on the Fed raising rates. Every month that people earn zero on their savings the more likely it is that they will not have enough in retirement, “seven, eight” it’s not to late All you need is 6%. You will have to look at alternatives but they are out there.

Dan Perkins

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