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Investment Returns
by Gary Foreman
Question: I have read lots on saving money and retirement. In most of
the articles it states you can get a return of 10% or 12%. Where do you
go to find this kind of earnings? If you have to invest in the stock
market, where do you find a person to help you do this without them
getting most of your money for helping you? Thanks. ~ Joy
Answer: Joy asks two very good questions. What is a reasonable rate of
return for her retirement savings? And, what does she need to do to earn
it?
We'll begin by looking at the return question. Is 10 to 12% per year a
realistic goal?
The first thing for Joy to remember is that as the potential return
increases, so does the risk of loss of part or all of her investment.
But, not all risks are the same. She needs to evaluate the risks.
For instance, with a CD she'll have a bank guarantee that she can have
100% of her principal back any time she wants it (minus any interest
penalties for early withdrawal).
Or she could choose to invest in stocks. Greater risk, but also a
greater possible reward. The risk is different, however. No one can
guarantee that any stock, fund or market will go up in the next year. So
there's greater risk for the next year.
But, suppose that Joy is years away from retirement. If she'll be
keeping her investment for ten years and is willing to own a variety of
companies, the risk can be largely eliminated. For instance, the Dow
Jones Industrials have gone up in every ten year period going back for
over 100 years. Including the depression years.
One other interesting item. What Joy really needs to know is what the
Compounded Annual Growth Rate (CAGR) is. That's not the same as asking
what the "average" return is. The difference is in how compounding
affects up and down years. You could do the math manually, but a
financial calculator is much easier.
Back to Joy's original question. Is 10% possible? Yes, as a matter of
fact it is. The S&P 500 CAGR has been in the range of 10.5 to 11% per
year for 10 year periods since 1926. So if Joy can just do as well as
the historic market average, she should do ok.
What about bonds? Over the long term stocks will outperform long
risk-free bonds by about 6%. So if Joy wants to be in that 10% range
she'll need to stay with stocks.
Now to the second part of Joy's question. Where can she get advice in
selecting investments? Selecting individual stocks is not a good idea.
Finding a good broker will be difficult. When I was a broker we were
instructed to find 200 clients who could produce $1,000 worth of
commissions in a year. Very few retirement accounts are that large. So
Joy would always be at the bottom of the broker's list.
Joy will do much better investing in something called an 'index fund'.
Not only can an index fund earn you the stock market average, it will do
so with minimal expenses since it doesn't need a large staff to decide
which stocks to buy and sell.
The Securities and Exchange Commission (SEC) website describes an index
fund as a "mutual fund or Unit Investment Trust whose investment
objective typically is to achieve the same return as a particular market
index, such as the S&P 500 Composite Stock Price Index, the Russell 2000
Index, or the Wilshire 5000 Total Market Index."
Joy will need to do a little research before choosing a fund. But, it's
not something that's too difficult for the average adult. She can find
help online at The Motley Fool site www.fool.com. And there are numerous
books on the subject. Any by John Bogle are excellent. He's the man who
literally invented the mutual fund back in the 1950's and is a supporter
of index funds.
If Joy wants to take an active part in managing her retirement
portfolio, she might want to select a couple of different index funds.
Different indexes will behave differently in different economies and a
changing world. NASDAQ will be more affected by technology stocks than
the Dow Jones Industrials. For instance, if she's bullish on technology
she should have more of a NASDAQ index and less of the Dow Jones one.
Bottom line? Over the long term Joy should be able to earn about 10% on
her retirement savings without spending a lot of time or money managing
her investments.
About the author
Gary Foreman is a former financial planner who currently edits
www.TheDollarStretcher.com website and newsletters. Visit today.
You'll find thousands of money-saving articles.
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