Built on Facts

To me this is interesting. To people like my parents, whose retirement depends significantly on their investments during their maximum earning years (ie, now), “interesting” might not be the word they’d pick. Here’s a graph I pulled off of Vanguard, representing a $10,000 investment exactly 10 years ago, for three different asset types:

The top line represents an intermediate-term investment grade bond fund. Traditionally it’s a low-risk category of investment, with some ups and downs but mostly a relatively stable source of modest distribution growth. The middle line is a money market fund – effectively a savings account. No risk, low interest. Keeps up with inflation but not too much more. The bottom curve is the S&P 500., roughly reflecting the stock market as a whole. Guess which one best represents your average boomer retirement investment?

An entire decade is a total wash. Worse, even. It’s down probably 20 percent from 1999 when we were pushing 28.8 kbps through our phone lines.

It’s not entirely the fault of the recent housing/oil bubble imploding; the dotcom collapse in 2000 and 9/11 a year later wrecked the early end of our 10-year period pretty well.

I have no point here, really. It’s my profession to pay attention to numerical data, so I can’t help but pay attention to this stuff. But geez, when that the last 12 years of stock market growth have been wiped out completely you wish you were paying attention to something nicer.

Comments

#1 foole
July 11, 2009

Why would boomers have money in the stock market? Every bit of investment advice I’ve ever read is this: spread most of your money in the stock market while you’re you, but as you get older, start taking it out of the market and putting it into lower risk investments (for exactly the reason illustrated in the graph).

There seems to be a fundamental misconception that the stock market will continue to grow and while it certainly seems to grow over a long time scale, I see very little evidence that the growth is unbounded (though I’m not economist).
#2 Stephen P
July 11, 2009

No risk, low interest.

I would hope that one thing we have learned in the last twelve months is not to use the words “no risk” in connection with banks (or with much else, for that matter).

Three years ago I sold about half of my shares to buy a car. Who would have thought that the car would actually turn out to be a better investment?
#3 Miko
July 11, 2009

Your conclusion also depends on your data window. If you’d looked at the past 20 years, I bet stocks would end up on top nonetheless. As they say, the longer your time horizon, the more appealing stocks become.

And money markets aren’t even keeping up with inflation now; try adding gold prices or a dollarized CPI to your plot.
#4 Matt Springer
July 11, 2009

You are entirely right, foole. Nonetheless a lot of boomers were heavily invested in stocks. Two factors seem to have been the big ones. For some of them it was because their own risk tolerance was far too high for their investment horizon. For others it was because their fund managers skewed their target date funds much farther towards the equity side than was warranted.

Stephen: “No risk” as in “you won’t lose anything short of true catastrophe, and even then your losses will be reimbursed by the FDIC”. Which of course means nothing if Uncle Sam goes bankrupt. I’ve argued on this site that in fact that scenario is inevitable. (See here and here) Lots of people disagreed so take it with a grain of salt, of course. But even with those caveats money markets are about as safe as your money can possibly get. A true financial catastrophe and/or government bankruptcy is going to nuke almost every other investment vehicle even harder anyway.

Miko: I don’t doubt it, but unfortunately Vanguard’s plots only go back 10 years and I’m too lazy to generate the charts myself. However, money markets are keeping pace with inflation. In fact literally 0% interest is better than inflation at the moment – the CPI indicates we’re currently undergoing modest deflation.
#5 Russell
July 11, 2009

I suspect what hit a lot of people wasn’t just the stock market collapse, but the concomitant bursting of the real estate bubble. This was especially painful if their interest in real estate was leveraged. A $500,000 house now worth $350,000 is a 100% loss to someone who owed 70% on their home. Combine this with a 30% to 40% drop in their IRAs, and a lot of people are smarting.

So… who has been putting more of their portfolio into equities of late? And if not, why not? Isn’t this the time to buy? Or at least, a much better time than 2007?
#6 Eric Lund
July 11, 2009

Part of the problem was that too many baby boomers were not saving enough money, so they needed to take on additional risks to have some hope of generating the returns they needed. That’s the usual deal with investments: you expect a higher return on a riskier investment as compensation for the risk that the investment might blow up. The flip side is that you don’t want to put money you need in the short to medium term in a risky investment for the obvious reason that you will be hosed if the investment blows up at exactly the wrong time.

@Russell: The collapse of the real estate bubble certainly doesn’t help the innocent bystanders who got caught in it, but most of the people who did get caught can’t be considered innocent bystanders. Lots of people put little or no money down on real estate (sight unseen in many cases–there is a reason Californians are hated in every other state from the Rockies west) they intended to flip, and got stuck when the flip turned into a flop. Lots of people paid off their credit card debt by borrowing against the equity in their home and then proceeded to run up even more credit card debt. Many lenders offered “stated income” mortgages, also known as “liar loans”–needless to say, these loans tended to go to people who lied on the application. Then there is the negatively amortizing loan, i.e., the monthly payment does not cover the accrued interest, and the difference is added to the outstanding balance (this is how the option ARMs that blow up do so)–an idea so self-evidently stooopid that any halfway alert regulator (unfortunately, the ones who were were systematically cut out of authority) should have screamed bloody murder over the concept. Et cetera. If all you did was buy one house for 20% or more down during this decade, you have my sympathies, but you were in the minority of house buyers.
#7 CCPhysicist
July 11, 2009

You didn’t say if those graphs were in constant dollars. That is a non-trivial detail.

Matt@4: Anyone who is not diversified is a high-stakes gambler. (See my Madoff commentary back on March 21.) If you look at the prospectus for a “lifecycle” fund, you will see that the ones that are heavily in equities (long horizon) have gone up a lot since the start of this year, just as the ones that are heavily in bonds (short horizon) went down less last year.

I don’t get your point about the FDIC. Are you ignorant of the difference between how it operates (drawing premiums from regulated institutions) and how, say, the military is funded by borrowing from China? The important warning about putting money in banks is that there is a maximum amount that is protected for a given bank (not for each account, or ever for each bank branch, but for each bank). See comments about diversification.

Stephen@2 is effectively talking about that anomaly in the bond curve in the past year. That resulted from companies and individuals that have not yet been held accountable for giving AAA ratings to junk bonds that were invested in mortgages like one local example (where 5 million dollars went into a real estate deal where the business plan included never paying any real estate taxes).

I was going to make the point of Miko@3: At your age, you need to look at stocks with a 40 year horizon, not ten years, and do so in constant dollars. Similarly, your parents also need to look at stocks with a 30 year horizon, because (hopefully) someone in their 50s is not pulling all of the money out in 15 years. Some of it has to grow until you are 80, but the rest has to be in more secure investments than equities. Looking at a time window of 40 years will also include the two recessions that were as severe as this one, one period of stagflation, and one period where inflation was so bad that 10 year T-bills paid 14%. (Buying those at the top was the best investment pick my Mom ever made.)

And you should be investing at your age. I was able to save while I was a grad student. It is all about priorities. I just wish I had bought a house when I was in grad school.
#8 Uncle Al
July 11, 2009

Make the ordinate “constant dollars” to reflect crude buying power.

Look at your paycheck, boy. See the deductions for Social Security and Medicare? That is outright confiscation without compensation. You will never see a penny of it back, much less its lost interest, or recover its proximate taxation. If you pay healthcare insurance you will never see that, either. Some old fart will prolongedly die in luxurious discomfort on your tab while you are told to “walk it off and suck it up.”
#9 CCPhysicist
July 11, 2009

Eric@6:
If you haven’t done so, you need to read the “Ponzi State” article in The New Yorker

http://www.newyorker.com/reporting/2009/02/09/090209fa_fact_packer

The full article (registration required) is not just about Florida real estate. It also includes a look inside the changes in one bank’s lending practices after it bought a “liar loan” company that had been operating in California and institutionalized those practices to improve its profits and eventually destroy the bank.
#10 Matt Springer
July 11, 2009

The chart’s not inflation-adjusted (I think). This makes judging absolute performance harder, but it’s still useful for comparing the relative performance of the various asset types. The depressing thing about not adjusting for inflation over the 10-year period is that of course breakeven in price is not breakeven in buying power. A straight CPI calculation indicates that $10,000 in 1999 is about $12,800 now.

CC: Indeed I am investing, though in a quite liquid and low-risk portfolio. (I need to keep it liquid for a house down payment eventually). I’m also aware of the FDIC’s functioning, but the whole point of its being a government insurance program is that like Fannie and Freddie there’s an understanding that the government implicitly guarantees a bailout if things go south. This is looking alarmingly likely.
#11 Tom
July 12, 2009

I would say “none of the above.” Did your typical boomer invest a lump sum and then do nothing? A better analysis would be $1000 invested each year. Stocks will look a lot better under that scenario.
#12 CCPhysicist
July 12, 2009

Matt, if you actually believe what you write about Social Security, you *must* start putting money away for retirement *now* in addition to saving for a downpayement. Since you are in a low tax bracket right now, the best choice would be a Roth IRA. (Probably a good bet for anyone who expects tax rates to go up in the future.)

You are preposterously wrong about the FDIC. The linked article does not support your claim of a government bailout. It says the *insurance rates* paid by banks are going up to cover the insured (and only the insured) losses of badly run banks. It will come out of the return on your bank account, just like increased insurance rates for houses in a fire-prone or hurricane-prone area.

And “Fannie and Freddie” are completely different beasts from the FDIC. They serve to securitize loans, not insure them like the FHA and PMI do. The FDIC does not own your bank account in the way that Fannie and Freddie might own your mortgage.