Sunday, July 26, 2015

Helping 'Smart Buyers' Learn to Save and Invest Successfully for the Long Haul ... We Oldsters Have Many 'Lessons Learned' That We Can Share

In our economic lives, we are initially (1) consumers (toddlers and students) and later on (2) producers (whether wage or salary earners or entrepreneurs) and (3) taxpayers (including taxes of all kinds, such as federal, state and local income, property, sales, gas, utilities and indirect charges for tariffs, subsidies and the like).

It's a CPT (Consumer -- Producer --Taxpayer) thing for sure, but we're not taught to be good buyers along the way. That's where the Smart Buyer Club will try to offer some assistance to those interested and willing to challenge their longstanding views on various topics and their place in the world of economics.

In the end, economics is merely applied common sense or seeing both the 'seen and the unseen,' including the immediate and the future impact of our actions and inactions. But that common sense understanding usually comes only at  the end of the process and not at its inception.

So today let's begin, or continue, as the case may be, the process.  Herein we'll look briefly at the merits and simplicity of Smart Buying when it involves long term saving and investing.

A Smart Buyer will have developed a habit by early adulthood which emphasizes saving and investing for the long haul --- he will know not to borrow needlessly or excessively.

Individually I have long advocated and practiced an admittedly unorthodox style of investing --- either (1) a low cost S&P 500 index fund or (2) a low turnover portfolio which buys and holds a diversified basket of individual dividend paying blue chip stocks for the long haul. In my own case, I've done both but have had more success with #2, the method I've practiced for the past ~30 years.

So I recommend that individuals adopt the save and invest early in adulthood habit and choose either #1 or #2 as their simple, effective and perhaps boring plan. It's worked for me over many decades of both up and the inevitable down markets. But over time it's up and up by a lot over both inflation and other investing alternatives.

Now there's a just released study which points to #2 as the best choice for individual investors. Advisers' Stock Recommendations Drag Down Clients' Portfolios, Study Finds, provides the details:

"Investors trading stocks with assistance of financial advisers . . . are worse off overall than investors who trade independently, because their stock purchases underperform, the study says. . . .

There was “consistent evidence” that stock trades made by investors in conjunction with an adviser underperformed benchmarks as well as trades investors made independently, the researchers say.

Moreover, the underperformance was “particularly severe if the client-advisor contact was initiated by the adviser, suggesting that advisers actively approach clients with rather poor trading ideas,” the paper says. . . .

“We find that even without taking into account trading costs, which are typically higher for advised clients due to higher trading activity, the overall portfolios of advised clients underperform the portfolios of clients that always trade independently,” the researchers said in the paper."


And I recently came across the following common sense article which offers more food for thought for 'Smart Buyers.'  6 things to tell your grandkids about saving for retirement contains this valuable advice:

"Retirees: imagine starting over in your 20s, armed with what you know now. There would be no limit to what you could accomplish with decades of experience on your side.

Until scientists find a way to turn back the clock, the next best thing you can do is offer advice to the younger generation, particularly your grandchildren, so that they can avoid the pitfalls that only experience could help them navigate safely.

As your grandchildren graduate college and start their first jobs, now is the perfect time to teach them the importance of proper retirement planning, and the key tenets that got you to where you are today are still paramount: don't spend too much money, don't take on too much debt, and always plan for a rainy day. Continue to reinforce these concepts in the same manner your parents and grandparents did for you.

But just as cars and computers have grown in complexity over the years, so has the process of planning for retirement. Low interest rates, the impending extinction of pension funds, and increasingly complex financial markets require a far more sophisticated plan going forward.

You can help your grandchildren navigate these complexities by instilling upon them the importance of not just saving, but also investing by following six simple rules:
  • Invest in equities: Recent grads should be 100% invested in stocks for three reasons. 
  • First, equities have delivered an average annual return of 10%, which is the largest of any major asset class. Second, this cohort has a long time horizon, so if the market were to experience another dramatic selloff, they would have the time to build back any paper losses. Third, the effects of compounding will amplify returns over time.
  • Buy index funds: Active management of a stock portfolio requires skill, education, and experience. Younger investors have none of these, and those who try will be doing nothing more than speculating. Only buy low-cost index funds that track major indexes.
  • Never buy the company stock: Tell them to avoid the temptation to invest in their employer's stock. They may think that being an employee gives them an "edge," but it doesn't . . . .
  • Contribute monthly: Tell them to maximize 401(k) contributions to the point where an employer will match. Think of this as "free money" that's deposited automatically with every paycheck. Long-term investors ignore entry prices and never try to "time the market." They invest monthly no matter what the short-term trend in the equity market may indicate.
  • Establish a Roth IRA: Taxes are only going one direction, so millennials should set up Roth IRAs before their incomes exceed the legal limit for these highly advantageous retirement accounts. Paying the tax now while their tax brackets are lower and before the politicians raise them higher will ensure that they get to keep more of their hard-earned investment.
  • Learn how money works: Our educational system is utterly useless when it comes to preparing children for one of the most important subjects, which is how money works. Buy them books, pay for personal finance classes, have them sit with your financial adviser, and tell them to always keep three to four months of living expenses in cash (mandatory) because bad things will happen to them.
The days of easy retirement planning are over and won't be returning for a very long time, but you can help them get on the right track by following these guidelines."

Summing Up

The foregoing is solid general advice for young, middle age and old investors, one and all.

That said, I differ with the writer about what Smart Buyers should assume as the likely annualized rates of return on stocks going forward. While the writer is correct in stating that stocks have returned annually 10% on average these past several decades, that's not likely to be the case in the foreseeable future.

And there are several reasons why an annual average return on stocks in the future of ~6% to 7% is more likely than the 10% historical rate. 

First, I foresee lower inflation in the future, which by itself is a good thing. Thus, a 6% return in a 2% inflation environment would be the same as an 10% return in a 4% inflationary economy. That leaves 2% unexplained since 6-2 is 2 less than 10-4.

Besides lower inflation, here are five other important factors which I believe will negatively impact future economic growth and stock market returns: (1) debt levels are higher; (2) our society is aging; (3) women, already now a big part of the workforce, won't be an additonal large adder going forward; (4) fewer people as a percentage of the total population will be working; and (5) our unproductive public sector (local, state and federal) will continue to grow at the expense of the more productive private sector. Facts are stubborn things.

Still, the returns on stocks will exceed those on bonds, cash, real estate and gold by a whole bunch both over the next several years and over a longer period of time. They always have and they will continue to do so. 

So regardless of these future 'headwinds, Smart Buyers will make regular contributions to their 401(k)/IRA and invest in either a low cost index fund or a diversified basket of dividend paying and growing stocks.

And Smart Buyers will know enough to pay low cost but knowledgeable financial advisers to help them benefit fully from the compounding 'Rule of 72' over their working career.

Perhaps the best advice the Smart Buyers need to follow, however, is something not yet mentioned: AVOID UNNECESSARY DEBT.

You see, that money which we get as 'producers' and isn't kept but is instead 'consumed' is money that can't be saved. And money that isn't saved can't be invested.

And the 'Smart Buyer' knows what's smart and not smart to do ---- while he's still young enough to do something about it.

That's my take.

Thanks. Bob.

No comments:

Post a Comment