Archives for February 2009

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A quick favor to ask: Have any data on gold?

Does anybody happen to have any idea where I might be able to find up-to-date info regarding long-term gold returns? I’ve been searching online for a few days now and have had very little success.

Something like an updated version of the data in Jeremy Siegel’s Stocks for the Long Run would be great. Best-case scenario would be year-by-year prices, so I could calculate standard deviation and other similar stats.

Any help would be greatly appreciated!

Update: Thanks to “Frank” from Bad Money Advice. 🙂

Worry-Free Investing

I find it telling that Leo from Zenhabits was able to gain tens of thousands of subscribers to his blog in less than a year. Yes, Leo is an excellent writer. But I suspect that a large part of his success was the result of him tapping into an already-existing, unsatisfied desire for a simpler way of living.

Whatever the cause, people in our society are stressed out. And as you can imagine, the economic turmoil of the last several months has only made things worse.

It doesn’t have to be that way.

Thankfully, investing doesn’t have to be stressful. How do I know this? My own IRA is down roughly 40%, and I’m approximately as concerned about that fact as I am about how well the San Diego Padres will do this year. (Hint: I’m not from San Diego, and I don’t follow baseball.)

Now, I’m not sharing this as some sort of boastful display of confidence (or stupidity, depending upon your perspective). I’m sharing it in the hopes that some of you who are worried about your money right now will realize that you don’t have to be.

It’s simply your choice.

Just stop worrying.

If you’re following a strategy that makes logical sense, and that has proven historically to be successful time and again, what reason is there to worry? I have yet to see anything in the news that makes me doubt the long-term wisdom of owning a diversified portfolio of profitable businesses.

And for those of us with more than 10 years or so to go until retirement, a big decline in stock prices isn’t a bad thing at all. If anything–given that we’re still buying–lower prices are good.

Want a step-by-step strategy for worry-free investing?

  1. Choose a few low-cost mutual funds, and start dollar-cost-averaging into them.
  2. Stop paying attention to news about the stock market.
  3. Adjust your asset allocation (slightly) toward debt investments as you near the time at which you expect to start selling your investments to raise cash for paying the bills.

That’s it.

Added bonus: Not only is it worry free and easy, it’s also more likely to prove successful than just about any other investment strategy out there.

Guesstimating Probability

For whatever reason, there’s been a great deal of talk recently about some research done in the 1970s by Amos Tversky and Daniel Kahneman. It’s been discussed in Predictably Irrational and Nudge as well as in numerous articles/blog posts.

In short, what Kahneman and Tversky showed is that humans aren’t the best at making rational choices. For instance, Kahneman and Tversky were able to show several real-life instances in which people make blatantly irrational choices. (Such as cases in which people prefer A to B, prefer B to C, and prefer C to A–entirely irrational, but apparently common.)

How does this apply to investing?

One thing that they showed in their research is that people aren’t very good at estimating the probability of various outcomes. Unless we have actual statistical data in front of us, our brains use the following method for estimating the probability of an event: We ask ourselves “How easy it is to come up with real-world examples of such an event occurring?” The easier it is to come up with examples, the more probable we assume the event to be.

Unfortunately, this leads to 2 very strong biases:

  • Recent events are much more fresh in our minds. As a result, we tend to assume that a reoccurance is far more likely than it really is.
  • Dramatic events are impressed quite vividly upon our memories. As a result, it’s very easy to access those memories, making us therefore assume that such events are more probable than they really are.

What does this tell us about how we might respond to Recent Worldwide Financial Crises? Do you think it’s possible that people are ever-so-slightly overestimating the probability of such an event being repeated? 😉

Charles Schwab IRA Review

I recently opened a Roth IRA with Charles Schwab.

It’s not my primary IRA–that’s with Vanguard. In fact, the only reason I initially opened the account was to take advantage of Schwab’s 2% cash back credit card. (With the card, the cashback bonuses are deposited into a Schwab brokerage account. From there, you can have the money swept into a Schwab IRA.)

That said, I’ve been quite pleased with Schwab so far. Over the last year, they’ve become significantly more appealing to buy & hold investors like myself due to their reduction in trade commissions (to $8.95/trade) and release of commission-free ETFs.

Schwab Commission-Free ETFs

Schwab’s selection of in-house ETFs (on which they don’t charge trade commissions) seems to grow by the month. Currently the selection includes:

Domestic Stock ETFs

  • SCHB: A domestic, broad-market ETF, with an expense ratio of 0.06%.
  • SCHA: A domestic small-cap ETF with an expense ratio of 0.13%
  • SCHV: A domestic large-cap value ETF with an expense ratio of 0.13%

International Stock ETFs

  • SCHF: An international equity ETF with an expense ratio of 0.13%
  • SCHE: An emerging markets ETF with an expense ratio of 0.25%.

Bond ETFs

  • SCHP: A TIPS ETF with an expense ratio of 0.14%.
  • SCHO: A short-term US Treasuries ETF with an expense ratio of 0.12%.
  • SCHR: An intermediate-term US Treasuries ETF with an expense ratio of 0.12%.

Between those 8 ETFs, you can easily put together a diversified portfolio with super low costs.

No-Commission Treasury Bond and CD Purchases.

Also, at Schwab you can purchase Treasuries (both TIPS and nominal) at auction without paying any commission. Purchases of new-issue CDs are commission-free as well. So if you would prefer not to use a bond ETF, you can just put together a CD or bond ladder for the fixed-income portion of your portfolio.

Schwab Customer Service

To date, I’ve only contacted Schwab’s customer service once. At the time I called (a weekday afternoon), there was literally no hold time. Of course, I can’t say that would necessarily be the case at other times of day or on weekends. And I have yet to contact their customer service via email, so I can’t say anything about that one way or the other.

Where to Open an Account

If you think Schwab might be a good fit for you, here’s the page to open an account.

I didn’t buy in order to sell.

Do you care what the current market value of your TV is? What about the market value of the shirt you’re wearing right now? Or the market value of your cell phone?

Of course you don’t care. Why? Because you didn’t buy them with the intention of selling them. You bought them with the intention of using them.

What about your home?

Many people make the same argument about your home: Don’t buy it with the intention of selling it. Instead, buy a home that you could reasonably see yourself living in until the day you die. That way, you don’t have to worry about fluctuations in its market value. Such fluctuations simply won’t concern you, so you can ignore them entirely.

What about your stocks?

What if you were to take the same approach to buying stocks? Buy them without the intention of selling them. Ever. Instead, plan on holding them exclusively to take advantage of the dividends they provide. It would certainly free up your mind a bit, wouldn’t it? You wouldn’t have to worry about giant drops in the market. (Granted, you’d have to worry about declines in dividend payouts, but those are less frequent and far less severe.)

In fact, for generations, this is exactly what investors did. They bought stocks with the intention of relying exclusively upon the dividends for their return. They had no intention of ever tapping into their capital by selling shares. It was seen as a strict no-no.

Unfortunately, a literal application this strategy isn’t as practical now as it was several decades ago when dividend payout ratios were much greater. Today–with a dividend yield of 3% being seen as high–investors are forced to rely (at least in part) upon their stocks appreciating in price.

However, I think it’s still a great attitude to have when thinking about your investments. Don’t worry so much about their current market value. Focus instead upon the fact that you own companies. And those companies make money. (Most of them, anyway.) And over a long enough period of time, your earnings are tied to their earnings–not to short term fluctuations in the market.

Have you run the numbers?

Trent at the Simple Dollar recently wrote a post sharing a question he received from a reader. Here’s what the reader asked:

I’m twenty eight years old and am now debt free. I’d like to start investing, but I have almost no tolerance for risk. I don’t mind not earning a great return because of this, but the thought of losing any of my investment makes me feel very uncomfortable. Any suggestions?

Many people would read this and commend the investor for being sufficiently self-aware to recognize a low level of risk tolerance. And on the one hand, I completely agree. It’s good to know ahead of time that a decline in your portfolio value is likely to impact you in a significant way emotionally.

Here’s my problem though: “I don’t mind not earning a great return because of this.” I’ve heard that exact sentiment voiced by friends/coworkers, and it seriously concerns me.

What worries me is that people seem to assume that “not earning a great return” simply means that they’ll never be fabulously wealthy. In reality, it likely means that retirement will be nearly impossible without a drastic downgrade in quality of living.

For example…

Let’s run the numbers for the above (28-year-old) investor, using the following best-case-scenario assumptions for a “no risk” investment plan:

  • The investor, seeking low volatility, invests in Treasury Bonds, and earns an annual return of 5.5% over her lifetime. (They actually earned 5.2% from 1928-2008.)
  • Inflation averages 3% over the investor’s lifetime. (It’s actually averaged 3.25% historically according to the U.S. Department of Labor.)
  • Social Security will provide for 40% of her cost of living in retirement.
  • The investor plans to retire at age 65, thereby giving her 37 years to accumulate the necessary capital.
  • The investor’s cost of living is currently $40,000

How much will the investor need to accumulate in order to retire? Approximately $2.86 million. And at a 2.5% after-inflation rate of return, how much would she need to invest every year to get there in 37 years? Just over $25,000.

I think we can all agree that’s nearly impossible.

What about with a diversified portfolio?

In fact, even if we assume the investor was 50% in stocks and 50% in bonds, thereby earning a 7.13% annual return over the period (the average of the 5.2% earned by bonds and the 9.07% earned by stocks), she’d still need to be investing $10,495 each year. Not impossible, but certainly not easy for a person making $40,000.

In short, if you’re truly OK with the idea of not retiring, then “not earning a great return” might be just fine. If, however, you are planning to retire, it’s probably a good idea to look into owning stocks. 🙂

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