Finance 101: May 2023
In May the financial advisors at Ruedi Wealth Management wrote 4 more “Finance 101” columns for The News-Gazette’s Business Extra section. Make sure to look for them every Sunday, but in case you missed the columns from May all four are below.
3 Years of Columns
Paul R. Ruedi, CFP®
This week I realized I let a milestone slip by: this April marked three full years of writing these “Finance 101” columns for every Sunday paper. Hundreds of columns later, hopefully we have all learned something. As I looked back on the three years we have been writing columns I realized that particular time period was a great case study in what it means to be an investor in the great companies of America and the world.
We started writing these columns in mid-April of 2020. Those were the days everyone was constantly looking at Johns Hopkins chart of new Covid cases and deaths across the country. People were buying up all the toilet paper and staying completely isolated to “flatten the curve.” It was a terrifying time in general, and even more so for investors. The economy was essentially shut down and it wasn’t clear when things would return to normal, if ever.
At that time the S&P 500 was hovering around 2800. Having bounced off the pandemic lows extremely quickly, it was still right up against bear market territory. People weren’t exactly shouting from the rooftops that this was a buying opportunity. More were worried that the other shoe was going to drop.
Then seemingly out of nowhere, the S&P 500 shot back up to end 2020 with double digit returns. 2021 was even better, with returns of over 26%. Of course, the market gave some of that return back the next year, when it dropped close to 20% in 2022.
But even with this most recent drop, the S&P 500 stands around 4,100 as I write this – that is an increase of around 46% since we began writing these columns three years ago at the depths of the Covid decline. Of course I must mention past performance is not an indication of future results. But when the market is down like it has been for over a year, sometimes it is helpful to zoom out and see how far the market has actually come in a fairly short period of time.
What will the next few years hold? Nobody can predict. Should we expect a 46% return like we have seen since we started writing these columns three years ago? I can’t rule it out, but I wouldn’t bank on it. Will there be plenty of crises both large and small ready to scare investors out of their investment portfolios? Certainly. The key to success in investing is holding on through the tough times to reap the returns we have had over the past three years. That will never change.
Are Americans Saving Enough to Retire?
Paul R. Ruedi, CFP®
According to the most recent data from the US Bureau of Economic Analysis, Americans saved around 5.1% of their incomes in the month of March. Is that enough to put them on a path to retirement? I decided to work through an over-simplified example to find out.
Suppose a person makes $50,000 per year and wants to replace 80% of that income in retirement through portfolio withdrawals. To provide this $40,000, they decide to accumulate a $1,000,000 portfolio and withdraw 4% per year. This person has chosen to invest in a 100% stock portfolio leading up to retirement that returns 9% compounded annually (slightly less than the historical average return of the S&P 500).
Saving 5% of salary each year, ($2,500) it would take that person just under 41 years to reach the $1 million retirement goal. That would put people who start in their early 20s on track to retire in their early to mid 60s. This was somewhat of a surprise to me, as I expected to have to break the bad news that saving only 5% was never going to get people to retirement. But I suppose even small amounts of early saving can grow to substantial sums if given four decades to do so.
The problem is, most Americans do not have 40 years to wait until retirement. If they wanted to accelerate the process by saving more, a 10% savings rate would shorten the time required to reach $1 million to around 33.7 years. Increasing savings to 20% shortens the time required to 26.3 years. Even saving a whopping 30% of salary would require over two decades, 22.2 years, to reach the $1,000,000 goal.
This brings up a couple lessons. The first is the incredibly important role of compound interest in producing large enough sums to retire. The example shows there is almost no way of getting around the need to be patient for at least a couple decades even at high savings rates. Those who start late have to save so much more to achieve the same retirement goals, that it can become borderline impossible.
The second is that retiring very early requires such an astronomical savings rate, it comes at a material cost to your lifestyle right now. The benefits of saving more must be weighed against what is sacrificed along the way. There is no one-size-fits-all “good” savings rate, but simply what works best for you. If you need help determining what savings rate is the best fit for you, you may want to talk to a financial planner.
Paying vs. Affording
Paul R. Ruedi, CFP(R)
I was recently visiting a friend when he said something that surprised me. He and his wife bought a house a few years ago in a nice neighborhood. As we all know, home prices increased dramatically across the board over the next few years. It would have been the perfect circumstance in which to stretch your borrowing power for a house. They are financially stable and never seem to be stressed about money. So naturally I was surprised when he said very bluntly, “I wish someone would have told us we really couldn’t afford our house.”
Growing up I received a handful of financial lessons. One of the most important is the difference between being able to pay for something and being able to truly “afford” it. Sure, you may be able to pay for an expense now, but if that spending requires taking on debt or is costing you some other important financial goal, you may not be able to truly afford it. But the fact of the matter is, most people live beyond their means, and when you see other people with nicer houses and newer cars than you, the temptation to follow suit really burns deep.
This is made even worse by the fact that lending institutions enable you to borrow more than you can really afford to spend. I always remind people that banks will lend you the money to buy a house you can’t really afford. Car dealerships will allow you to finance a more expensive car than you can really afford. Let’s not forget how credit cards enable people to “pay” for things they clearly can’t afford. Minus giving you a certain credit limit, credit card companies don’t care if you are making purchases you clearly can’t afford. Given that they make money when you pay them interest, they actually want you to buy things you can’t afford.
This issue also impacts retirees who are spending the wealth they accumulated through diligent saving. Retirees may see a large portfolio balance and assume they can pay for big ticket items now, only to find it leaves them short of their goals down the road. Running to the extreme, retirees with a $500,000 investment portfolio to live on likely shouldn’t buy a $250,000 sports car. Sure, they can pay for it now, but they’ll likely end up having to live in it someday. If you have some things you’d like to pay for but aren’t sure if you can actually afford them, you may want to talk to a financial planner.
Market Timing the Debt Ceiling Crisis
David Ruedi, CFP®
Though we can talk about the folly of market timing until we are blue in the face, there will always be a short-term concern on the horizon that will tempt people to get out of stocks "until things get better." Lately, worry about the debt ceiling is tempting many people to time the market. It seems like a fairly sensible idea, but looking past the surface level, you start to see problems with this strategy.
First, what everyone assumes is going to happen may not happen. People are concerned that the U.S. will reach the debt ceiling and be unable to pay its bills, but that may not occur. Politicians may finally get together and come to a compromise to raise the debt ceiling. After all, they have successfully done so 78 times in the past, according to the U.S. Department of Treasury.
Second, even if a deal to increase the debt ceiling is not reached, it's uncertain how the stock and bond markets will perform. Since everybody knows there's a possibility the government won't make a deal before the debt ceiling is reached, you could argue this information is already incorporated into market prices.
But let's suppose what everyone is worried about happens. The government can't get a deal done, and the stock market declines significantly. Even if you successfully avoid the downturn, you still have the equally difficult task of deciding when to get back in.
Most investors plan to wait until the crisis has passed, but at that point prices will likely be higher than they were leading up to and during the crisis. Comeback rallies happen so fast that they can be easily missed. Even worse, once prices have risen, they may never look back, and you can permanently miss out on investment gains that were there for the taking.
Timing the market in advance of an expected crisis seems like a sensible idea. But it breaks down in practice because you can't predict if a crisis will actually occur or if the market's response will be what you expected. Even if what you expect does happen, you may miss out on a recovery rally and buy at higher prices than when you sold.
Fortunately, you don't need to time the market to have a successful investment experience. Investors can reasonably expect to be rewarded for simply buying and holding a diversified portfolio of stocks and bonds as long as they stay disciplined during the temporary declines that happen along the way.
Disclaimer: Past performance is no indication of future results. You should not make any investment decisions without first performing your own due diligence and consulting your financial advisor.