Invest Less, Make More

Invest Less, Make More

There are only three things you can do with money

1. Spend it (a cash flow system)
2. Save it (protected money)
3. Invest it (potential money)

The majority of effort in our society is placed on investing.  But is this the best strategy? Let’s look at how the financial planning industry represents their returns.

The common mantra is to put your money into the stock market and leave it there. Why? Because it always comes back and the average for one hundred years is over seven percent, or so the saying goes.

In fact, the Dow Jones Industrial Average (DJIA) for the past 100 years is 7.26%.

Let’s see if that fairly represents the situation. If you were to put $1,000 into the DJIA in 1909 what would it look like in 2008, 100 years later?

You can check this with online calculators or your own financial calculator. Take $1,000 as your present value (PV), 7.26% as your interest rate (INT), 100 years as your term, and solve for future value (FV) compounded annually.

The value of your account in 2008 is $1,106,061. (If you got $1,391,484 you compounded monthly.)

However, had you actually invested $1,000 in the DOW in 1909, your account balance would be $142,954. What happened? That’s $963,107 less than it should be. Let me illustrate:

Let’s say you invest $10,000 with Sue, your Financial Advisor and she earns your account a 10 percent return. You made $1,000 and your new balance is $11,000. Easy math.

Year two your account drops 10 percent. How much did you lose? If you said $1,100 you’re right and your new balance is $9,900. That’s $100 less than you started. So what is Sue’s average rate of return for your account?

Year 1 = 10%                        Year 2 = (10%)            Average = 0%

How do you feel about those numbers? Is the average an accurate representation of what happened to your account balance?

Something seems out of whack here and that’s because your ending balance is lower than your beginning balance. Yet she represents your average rate of return as 0 percent, when it is actually less than 0 percent.

You see there is a difference between average rate of return and actual or compound rate of return. The DJIAs actual rate of return for the past 100 years is 5.09%.

Assuming a 15 percent tax bracket, your actual return is 4.61 percent. Since nobody works for free, let’s add in a 1.5 percent management fee (much less than average) and the DJIAs rate of return is 3.51 percent.

In other words, if you could have put your money into an account that averaged 3.51 percent or higher and was tax favored, you would have out produced the DJIA since 1909.