About 95% of investors who are doing something other than buying a low-fee index fund are under performing the S&P 500. Does that qualify as a “bad investment”? Or just run- of-the-mill ignorance and innumeracy?
intercst
3 Likes
You assume that every investor, regardless of their circumstances, needs to match or exceed the performance of the SPX – or you condemn them for ignorance and innumeracy. That’s pretty arrogant considering the past volatility of the SPX.
Maybe the urge to speculate is a sign of cognitive decline in a person who would otherwise be more cautious.
Wendy
6 Likes
Not at all. People investing in individual stocks or actively managed mutual funds are likely experiencing even more volatility than a broad-based index like the S&P 500. I’m merely citing 100 plus years of stock market history and the documented individual investor performance from DALBAR and others.
I know it’s painful for a lot of people, but merely buying & holding the S&P 500 (or any other broad -based index) has historically beat about 95% of active managers and even a higher percentage of individual investors trading stocks on their own.
The way I explain it, “What if I told you there was a way to go to engineering school, never attend a class, or crack a book, and still get an income equal or exceeding all but the top 5% of your impressively credentialed classmates, would you take that bet?”
That’s what a long-term, buy & hold investment in the S&P 500 (or other index) is offering you. But of course, there’s a whole sales & marketing industry that’s trying to get you to buy something that pays a higher commission with a far lower chance of success.
intercst
6 Likes
Is it because stock picking is hard or is it the fees and taxes that are avoided by not selling?
I switched to discount brokers the year I barely broke even while my full charge broker charged me $50,000.
The Captain
1 Like
Both.
Very few people have excelled at stock picking over the long run. It’s basically Warren Buffet and James Simons of Renaissance Technologies and no one else.
The stock market didn’t become attractive to me until fixed brokerage commissions were outlawed as price fixing by the SEC on July 1, 1975. Prior to that, small investors were losing 8% to 10% of value to transaction costs on the purchase or sale of 100 shares of stock. It was worse than buying a home.
Things got better once Charles Schwab kicked off discounted commissions shortly after the SEC rule became effective.
When I quit working in 1994, I had a portfolio of about 20 stocks and only make 1 or 2 trades per year. My annual trading costs were 2-3 basis points over the value of the entire portfolio, versus the 0.20% of assets Vanguard charged at the time for its S&P 500 index fund.
Today, nearly 50 years later, Fidelity will sell you an S&P 500 index fund with in annual expense ratio of 1.5 basis points or 0.015% – just $150 per $1MM invested. That’s almost “skim-free”.
intercst
3 Likes
You might be right if investments are limited to stock picking with a 10 year or more investment window. If not, then you have to consider the cost of risk. For example, those who have saved enough for retirement might reasonably decide to put a big chunk into annuities so as not to have to worry as much about whether China invading Taiwan is going to impact their planned European cruise. The shorter the investment window, the less attractive the S&P investment.
Another example would be if your primary residence is in an area that tends to significantly increase in value. Under those circumstances you might be better off paying off the mortgage than investing in stocks, even if the latter appreciates at a higher rate. The reason is the capital gains exclusion for primary residence that could be as high as $500K.
1 Like
The numbers don’t lie. Perhaps you can split it up into two phases, the accumulation phase, and the distribution phase. During the accumulation phase (the 30 to 50 years between age 18 and retirement) there is no doubt at all that for the vast majority of people simply accumulating (those monthly contributions to retirement, either tax-advantaged or taxable) in some sort of wide index fund will outperform anything else for the vast majority of people. During the distribution phase, and beginning a few years before it, it is prudent to slowly balance out of equities and into “cash” (some sort of short-term or laddered fixed income) for some number of years of estimated withdrawals.
Moving into annuities is great for some people … and those people are the folks who sell you the annuity and the folks who work for the insurance company that provides it to you. Unless, of course, you believe that the insurance company is so nice that they will sell you something without taking any profit off the top (and believe me, they all take a heck of a lot of the earnings).
Some people can invest in real estate profitably instead of in a simple wide index fund. However, this has been well described as “a lightly taxed second job”, and it is indeed a job of sorts. Also, you have to be somewhat lucky and choose the proper location for your real estate, otherwise you will experience middling overall returns despite all the “second job” effort you put into it over the years.
Again, these generalities apply to most people out there (the vast majority). Exceptional people will have exceptional results in their own chosen investment path.
5 Likes
intercst, some will look at the S&P 500 annual returns and view it as too volatile[1]. You forgot[?] to mention that you keep 5 years of living expenses in less volatile asset classes [MMF, CDs, ?, etc] so that you will not have to sell stocks in a bad year thus preserving one’s stock portfolio. Retiring in 1973 or 2000 with all of one’s money in the S&P 500 would have been disastrous.
The S&P 500 over the long haul is a sure bet. But there have been 2 or 3 years periods of p*ss poor returns. Aberrations to be sure. Aberrations that one’s portfolio must be protected from being impacted.
[1]
2 Likes
intercst has a Retire Early website.
He covered: The 4% Withdrawal in Bad Times.
4 Likes
Absolutely!
History shows you want to be 100% stock up until 10 years before retirement. Then move 4% per year over the next decade so that you retire with a 60/40 portfolio. That 's what’s required to survive a retirement starting in 1929 just before the Stock Market Crash and Great Depression, or the poor stock market returns and high inflation of the 1960’s and 70’s. Then if you happen to retire into a good stock market and have no need to increase your spending, you can reduce the cash position over time.
intercst
2 Likes
Maybe but probably not. If you are thinking you will see some price appreciation then you don’t want to pay off the loan, you want to borrow more.
For example, let’s say you own outright a $500K home that appreciates by $50k giving you a nice 10% return.
Or let’s say you put $100K down, and got a loan for $400K on that same house. It appreciates by $50K giving you a whopping 50% return.
The only benefit paying down the loan early gives you is the interest savings. That’s not nothing, but most mortgages are low interest and fixed rate and the money can be put to more productive use elsewhere.
3 Likes
Mostly human nature, I think. Recall the mood on this board back in March, 2020. The investing consensus at that time seemed to be flight to safety. In fact, it was the buying opportunity of a generation.
5 Likes
Some surveys indicate that a majority of Americans believe they are living paycheck to paycheck. More Americans say they are living paycheck to paycheck this year than in 2023—here's why
If that is true, then it suggests that a lot of home owners are having some difficulty making their mortgage payments. Should these folks focus on reducing debt by paying down their mortgage, or should they be moving more money into the market?
Let’s say you make a million dollars in the stock market. You will pay 15% capital gains on that $1M. Let’s say you and spouse make a $1M profit on your primary home. Because of the capital gains primary home exemption, you would only pay capital gains tax on $500K.
If you live in an area where housing tends to appreciate rapidly that tax advantage could be a difference maker. It makes sense to increase ownership in a rapidly appreciating asset that also provides capital gains tax advantages. There is also the unfortunately (IMO) under-appreciated value of reducing risk by reducing debt.
1 Like
More money to the market, absolutely no question. A person in that situation should never be putting money in the house. Too much risk for too little reward.
Let’s say the homeowner in that situation doesn’t have a lot of extra cash each month, but they dutifully put $150 towards the mortgage each month in hopes of becoming debt free.
At say, year 12 they’ve made quite a bit of headway on the mortgage but still have a long way to go and disaster strikes. He gets hurt, can’t work, and loses his job. After a few months the bank forecloses and all those extra payments are lost to fees and penalties. Our homeowner winds up with almost nothing to show for all those extra payments.
Or let’s say they dutifully put $150 to work in the market. The market doesn’t do great, a mere 5% annually. Disaster strikes and the homeowner loses his job. But a second disaster strikes and there is 25% market crash at the same time! Our home owner has about $21,000 in the market. He can continue to make the house payments for possibly years until he can get back on his feet. Plus most market crashes are short lived. When he gets another job he’ll have the house and still have a nice next egg too.
If you want to retire the mortgage, a far safer strategy than paying extra is to create a sinking fund and then pay it all all at once, or possibly recast it if that makes sense.
I intended to do that once upon a time until I realized the gains on my sinking fund were far outstripping the interest payments. Now the gains are outstripping the mortgage balance.
Remember, you posited that paying off the mortgage was financially better than investing in stock. Taxes are part of that calculation, so let’s include them.
Let’s again say you own outright a $500,000 home, and you live in a place where real estate appreciates like crazy and so in five years it is now worth $1,000,000. A nice, 100% return that puts a cool $500k return in your pocket, tax free
Or lets say you put $500,000 down on a $2.5 million home at 6% interest. It appreciates 100% in five years. Now it is worth $5 million. You paid about $440K in interest, let’s just call it $500K (I’m assuming you get back the principle portion of the payments).
So $4 million gain. After the 15% tax, you have $3.4 million. Which is better $3.4 million or $500K?
To make it more apples-to-apples you could add back in the opportunity cost of the $440K in interest, but even doing so you are still way behind $3.4 million.
1 Like
No, they should focus on:
- Reducing their spending (get rid of the big SUV, cancel their 3.4 streaming services, get rid of the unlimited data plan and switch to a barebones cell service plan, stop the takeout and fancy coffee cold turkey, etc)
-and- - Increasing their paycheck (more hours, side hustles, second jobs, etc).
If you are living paycheck to paycheck, paying down your mortgage is one of the most risky things they can be doing! (I’ve explained why that is the case many times before)
More like 23.8%.
And you can avail yourself of this exemption every two years!
2 Likes