Easy Money

Today at work I eavesdropped on a conversation between two coworkers. They were discussing their financial plans for the future and the subject of retirement came up. One of them made the following statement: “If I’m not retired by the time that I’m 35 or 36 I’m doing something wrong. All you need to do is invest a few hundred dollars a month in the stock market and let it compound over time. In about 10 years you’ll have over a millions dollars and you can live comfortably off the interest alone.”

He then proceeded to enthusiastically regurgitate what his financial advisor had sold him concerning investing and the stock market. He made the claim that over the past 120 years the market has earned an average return of 10% per year including the great depression years. To him this was equivalent to the market returning 10% to every investor every year during that period.

I reflected on how often I’ve encountered this kind of thinking over the past several years. So many people are convinced that there exists an automatic wealth machine that anyone can use to guarantee themselves riches and an early retirement with virtually no effort on their part. For some this machine is the stock market for others it may be real estate, but either way the mentality is the same.

In addressing my colleague’s comments about the stock market it is important to remember that an average is exactly that. If an average over a long period of time was 10%, this means there were many years that returned less and many that returned more. The trick is to buy at the right time. John Mauldin in his book Bull’s Eye Investing, addresses this very idea.

“If you invested in the S&P 500 in 1966, it was 16 years before you saw a gain, and 26 years before you had inflation-adjusted gains. If you invested in the 1950’s or in 1973, your gains came more quickly. If you invested in 1982 or late 1987, your gains in only a few years were spectacular... In the 17 years from the end of 1964 to the end of 1981, the Dow Jones Industrial Average gained exactly one-tenth of one percent.” (Bull’s Eye Investing, pg. 11; 26.)

This statement implies that it is not how long you are in the market for but when you buy that makes all the difference. Looking at the current buying situation it is not a pretty picture. Perhaps the most depressing statement from his book for those who intend to retire in 10 years off a simple buy and hold strategy like the one my coworker advocates is this: “No stock market at the P/E levels we have seen for the past few years has ever returned anything to buy-and-hold index investors after 10 years. Period. No Exceptions.” He also asserts that “If the P/E trends down gracefully, then that means 10 years from now the market will essentially be where it is today. There are clear historical precedents for this.” (pg 36.)

He also quotes a study done by Hussman Econometrics which found that: “Stocks will be about 13 percent below current levels a decade from now. Add in dividends and you’re looking at zero total return over a decade… If you are interested in long-term returns, it is madness to try to squeeze 9 percent out of a market which is priced to deliver zero.” (pg 37.)

Now don’t get me wrong. I’m not saying that you can’t make money in the stock market over the next decade. I’m simply saying that the traditional buy and hold, mutual and index fund strategy is not going to produce any significant gains over that time. Sure people have used this method to make a lot of money in the past during bull markets, but if they didn’t personally know when to get out, their gains where wiped out by the next downturn. That is the problem with the blind, buy-and-hold strategy. What goes up also comes down. To make money you have to buy low and sell high. This is also the problem with giving your money to a manager and not knowing what he’s doing with it. Worse is letting him tell you when and what to buy when you have no knowledge of the markets or the investment vehicle you are buying.

Some will surely say, “But don’t money managers know what they’re doing? Won’t they get you out before you lose a bunch of money?” The answer is no. The large, institutional investors don’t have the incentives to do any such thing. Most of them make money simply by convincing you to let them manage your nest egg. Obviously they will always tell you that now is the time to buy and that never is the time to sell. They are salesmen first and foremost.

Letting someone else manage your money can be a good thing, but only if you know enough to pull your money out of bad situations and move it somewhere more productive. Your investment advisor most likely will not do this for you or tell you that you should. Many “financial planners” today are recent college dropouts or stay at home moms that go through a three week course where they’re taught how to tell everyone the same thing and sell them all the same cookie cutter financial “plan.” Entrusting these people with your money for the long term is madness. To think that they can consistently make you real money in markets where you are competing with lots of sophisticated, savvy investors around the world is delusional.

There are plenty of exciting and promising investment opportunities all over the globe that will make a lot of people very rich over the next decade. You just have to know where to look and when to strike. This is where the problem lies. Most people don’t know enough to confidently invest in domestic markets let alone in the international arena. Too many will fall prey to the age-old mistake of mindlessly doing what worked yesterday, even though yesterday is gone and the game has changed. You don’t have to be a stock market wiz, but you should at least be able to recognize general economic, political and technological trends that are occurring around the world and you must have the courage to pilot your own ship.

There is no automatic, effortless path to riches. You may get lucky, but if you don’t do your homework that luck will be gone as quickly as it came. Real, lasting wealth requires knowledge to attain and preserve. To believe that we get rich and stay that way in an increasingly competitive world without putting forth the effort to learn how it’s done is foolish. The United States, like the rest of the Western world is hamstrung by massive, meddling welfare states that have caused us to lose much of our competitive edge versus the third world. The future belongs to the East, not to the West. It also is not ruled by the past. Rather than looking back at what worked in the 90’s, we should be eagerly looking ahead for the opportunities that are coming. If we refuse or are unable to do so we will undoubtedly be disappointed. Our dreams of a long, easy retirement may be dashed on the rocks of our own ignorant behavior.