Quote:
Originally Posted by BlackVoid
Before you do this, take a look at the japanese stock market for the last 20 years. There is a fair chance that it is happening to other stock markets all around the world. A 20 YEAR BEAR MARKET. Hooray??? 
Investing is not that easy, you cannot just put money to the same place (stock market) and forget about it. It may work for 40 years, then there are ten years when it is a very bad idea. If that 10 years happens before your retirement, then you will have no retirement. |
Actually, I've done that analysis. The scheme I was recommending is certainly not
completely resilient in the face of a 20-year bear market, but it comes close. You need to consider a few things to understand this:
- You aren't just investing a lump sum at the beginning, and then asking "what will it be worth after 20 years?" If that was the story, you'd be completely screwed by a long-term bear market.
- Investing 7% of gross income every year (as an example) pushes you in the direction <yourCurrencyHere>-cost averaging. That is, if I'm investing $100 each month and the market is at $50 I buy 2 shares this month. If the market falls to $25, I buy 4 shares that month. My average cost per share is much more attractive this way. Especially because very long bear markets are quite rare.
- You should note that I recommended holding a significant amount of cash or cash-equivalent. This is exactly a hedge against a long-term bear market. As you get older, the percentage of your retirement fund that is in cash should get larger. A typical recommendation is <yourAge>% in cash (if you are very cautious) or .5*<yourAge>% in cash if you are not quite so cautious. Regular rebalancing to maintain this percentage cash helps you to buy more stock at lower prices and sell as the prices rise. Which is exactly the buy-low-sell-high that you need to make money.
- Sensible investors place part of their investment outside their local market. For a US investor, that means a World fund of some sort. Sensible Japanese investors would certainly have taken a hit in their 20-year bear market -- but should also have had some money invested outside Japan. This can't save you from a world-wide meltdown, but it really helps hedge against market problems driven by local policy failure (as in the Japanese case, or in "Kim-Il-Bob's" Zimbabwe).
- Even on the day you retire, you still have (on average) 20 years or more for the market to recover. In nearly all cases your cash hedge should see you through to enough recovery. Assuming, that is, that you've been investing all along.
- NOTHING protects you from a Weimar-Germany-style hyper-inflation. That's not worth worrying about (much) in retirement planning, because there's no practical individual solution.
I haven't run the numbers for the Japanese 20-year bear market. I have, however, run the numbers using historical US market data, including
ALL of the down-markets, depressions, and panics since stock market data in the US began.
The assumptions I used for returns on stock investments are that whatever the market did in a given quarter, your investments did 1% worse than that. In addition, I priced new investments for each quarter at the highest price for the quarter -- that is, assuming that you actually bought on the worst possible day each quarter throughout your career! Finally, I assumed that the growth in the retirement account is tax-free, but the money is taxed as ordinary income both when earned (e.g. before investment) and again when withdrawn from the account. This tax treatment is significantly worse than the current state of US law -- we actually pay income tax on retirement investments only once (either before putting $ into the retirement account, or after withdrawal, but not both). Further, post-retirement I assumed that any market sales took place on the lowest-priced day of the quarter.
Using these very pessimistic assumptions, there is no 10-year period in US history where the return for an account is worse than the inflation rate. None. Sliding a career-length window across the historic market and inflation data leads to the result that 7% of gross income starting at age 30 (a late start!) lets you retire at your final wage, and live at that standard for the rest of your expected life leaving a moderate-but-not-huge pot of money to your choice of heir (be it family, gov't, charity, or whatever) -- even in the worst possible choice of dates. If you get lucky on the economy you do better.
This is not a guarantee, of course. We could have hyper-inflation. We could have the fall of the Roman Empire (or equivalent) and go to hell in a handbasket. But for the majority of realistic scenarios, this plan would leave you in fine shape for your retirement.
It also shows what a bad deal Social Security is for todays workers, btw. In the unlikely case that SS pays me every penny they currently promise, I will see roughly a 1% return on that money -- before inflation. My sister's children who are just entering the workforce will see a negative return before inflation. If you are in the US and younger than 55, you are NUTS if you count on Social Security for your retirement -- even based on the promised return.
I don't want to rattle on too long about this. My overall point is that reasonable and sensible strategies can take you a very long way, leaving you screwed in only the
very most extreme circumstances. And when I compare against the promises made by Social Security in the US, we'd have to see economic times
very substantially worse than the great depression (for a longer period, too!) to screw up a simple plan like this one.
It's not rocket science. Really.
Xenophon