Monday, May 21, 2012

Putting “Long Term” Under the Common-Sense Microscope

Putting “Long Term” Under the Common-Sense Microscope

We hear it preached all the time in the investing world: if you want to be successful (and retire rich), you must take a “long term” view of the stock market. In other words, insofar as you invest in the market for a long term, you’ll do great.

Quick question: Do you buy that? I don’t! Of course, I’ll explain my contention.

Meet Senior and Junior

Senior has been investing in the stock market for the past 35 years and has accumulated $500,000. Junior, on the other hand, started out 3 years ago and has just $15,000 in his account. I think we’d both agree that Senior definitely qualifies as a long-term investor, but Junior doesn’t pass that test, right? Good!

Now, all things being equal, let’s say their investment increases this year by 10 percent. Senior would gain $50,000 (10 percent on his $500,000), ending up with $550,000. Junior’s investment would increase by the same 10 percent (note the key word same), earning him $1,500 on his beginning $15,000, for an ending balance of $16,500.

Since the stock market sometimes dips, let’s say the following year it loses 10 percent. Don’t panic! It’s just an example to drive home a critical point. Junior would lose 10 percent of his $16,500 which is $1,650, so he’d end up with a new balance $14,850. But how about Senior? How much would he lose? He’s been investing for the “long term,” so did he lose anything? Of course he did. And how much was his loss, compared to Junior’s?

Yes, this is pretty basic stuff (or shall we say it should be?), but bear with me for a moment as I drive home a valuable lesson.

The indisputable fact is that Senior’s account would experience the exact same 10 percent decline, regardless of his 35+ years in the market. Here’s how his numbers look: Losing 10 percent of $550,000, or $55,000, would whittle his balance down to $495,000.

It’s now pretty obvious that both Junior and Senior gained – and lost – the same percentages. However, in absolute dollar terms, Senior lost $53,350 more than Junior ($55,000 versus $1,650). Who do you suspect would feel more anxious about their retirement? Senior, the long-termer? You see, this concept is not specific to this example – that’s how variable investing works, period!

I have a rather simple request for those investing experts who believe strongly that investing for the long term is the key to a successful retirement: please define for us, once and for all, when exactly this so-called long term is. I’d like to know, as I think a lot of other folks would, too. I’m confused because it’s all over the map – depending on what’s happening in the market and who you’re talking to, the definition keeps changing.

I bet you’d tell Junior to think about the long term, like say 10 or more years. As for Senior, you’re probably more likely meaning 40 or more years, right? But what about those folks who’ve been investing for that long already? Gee, things are getting pretty tight here, right?

My dear, hard-working retirement investor, something tells me that investing your nest egg in the stock market is just plain risky – no amount of time will ever change the rule: it sometimes goes up and sometimes dips. And something also tells me that may not be the best approach at ensuring you’re going to have a secure retirement.
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