By Patrick Kerney
NFL Player Engagement
We are in the midst of a run-up in stocks that makes it easy for those of us who started paying attention to investments in 2009 or later to think of the stock market as a winning lottery ticket. The S&P 500, which is a common barometer to measure the price of a major portion of the stock market, has seen its price grow 190% (including dividends) from the bottom of the Great Recession (March 9, 2009) to today (October 27, 2014). That is an average of about 20%/year for the past 5 years.
Unfortunately these types of returns are atypical. Just ask someone who was invested in 2007-2008. The Great Recession ate up over 57.7% of the price at which the S&P 500 (which many investment professionals use as the gauge for the stock market as a whole) was valued before the crisis hit. Such are the ups and downs of the investment markets. While history is no guarantee on what the future holds, the returns over the long term (1926-2013) for the two main asset classes, stocks and bonds, are roughly:
- Stocks (S&P 500): 10.1%
- Bonds (10-year U.S. Treasury): 5.2%
That said, the general rule for investing states that the higher the return, the higher the risk. Stocks are seen as more risky because in the short term they generally have higher highs and lower lows. For instance, if someone had to take out money in 2009 to buy a house, they would have been in a tough spot if the money tagged for this expense had been invested 100% in stocks. It would have been worth roughly 43.2% of what it had been worth two years earlier. Either the house couldn’t have been purchased or they would have had to sell 2.3 times as much stock as they had originally planned. Had this money been 100% in bonds, it would have grown, albeit slightly, over this time and the house could have been purchased without plundering the family’s nest egg. That said, over the long run, a 100% investment in bonds would have left investors with a lot less money than someone with a 100% investment in stocks. This is why it is hard to create a quality general rule on how much we should allocate to each asset class. Every individual or family has a different timeline, cost of living, financial goal, risk tolerance, etc. This is where an intelligent, credible and ethical professional investment advisor can create value.
In terms of planning with reasonable expectations, we can get some idea on these numbers from various pension plans. Our Bert Bell/Pete Rozelle Retirement Fund, for instance, expects its investments to grow, on average, at 7.25%/year. Berkshire Hathaway, the company run by the undisputed king of investing over the past 50 years, Warren Buffet, expects to average a return of 6.9%/year for its pension. While these pensions have payouts to retirees due every year that restrict how much can be placed in higher risk/higher reward stocks, etc they also operate with much lower costs than most individual investors and a much higher level of expertise.
Lastly, it is important to understand the contrast of two different sets of return information. The first set, “gross return vs. net return” takes all investment costs into account. Gross Return doesn’t matter to the individual investor as there may be a good portion of that return he doesn’t get to keep. Net Return lets the investor know exactly how much of any growth belongs to him.
The other important contrasting set is “nominal return vs. real return”. Nominal return denotes the amount by which investors’ dollars have grown or shrunk. Real return denotes the amount by which investors’ buying power has grown or shrunk. The real return accounts for the increased price of goods and services year by year due to inflation. While it might make investors feel good in the short term to read or hear about their nominal gross returns, it is the real net returns that allow us to understand how our future lifestyles are affected by our investments.