Comparing Returns Against the Markets


This has definitely been a great time for stocks.  Ever since the election in 2016, stocks have been heading up.  The Dow Jones Industrial Average, an index often used to judge the returns fo the markets,  has risen about 25% since election day.  The S&P 500 index, a common index used to determine the performance of large US stocks, is up about 15% (16.7% if you reinvested dividends).

While I’m only really interested in long-term returns, I still like to periodically review how I am doing against the major indices to get some perspective.  I tend to invest a good portion of my money in individual stocks that I think will do well over long periods of time.  If I were to consistently get lower returns than I would have just investing in index funds, I might just shift to index funds since that would be simple and require very little effort.  In the very least, I might rethink how I invest and in what I invest in.

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Looking at the returns of the S&P500, I see that it has returned 14.32% since the start of the year.  Over a 1 year period, it has returned about 15.7%.  Looking at my IRA account, it has increased by about 18% since the start of the year and 31% over a 1-year period.  I have a second account that unfortunately hasn’t done quite as well, rising 12% since the start of the year and about 19% over a 1-year period.  It is outpacing the returns of the S&P 500 for the full year but lagging a bit year-to-date.  The Russell 2000 has returned 10.3% year-to-date, so the smaller stocks have not been doing as well as the larger companies.

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I’m investing long-term, so returns for a short period aren’t as important as the financial performance of the companies I own in general.  I believe that if I pick stocks that consistently see earnings grow in the 12-15% per year rate, I should see returns on that order over long periods of time.  Sometimes the price will fluctuate up or down due to other, unrelated factors, but eventually the stock price will return to the fair value dictated by the earnings and dividend growth of the company.


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Note, a great site to determine the return of the S&P 500 for any given period is at: https://dqydj.com/sp-500-return-calculator/ .  The nice thing about this calculator is that you can pick any period you want, and it also includes the effect of reinvesting dividends.  If that is included, my returns look even worse since the S&P 500 return with dividends reinvested is 8.3%.

Have a question?  Please leave it in a comment.  Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Beware the Fed


There is an old axiom on Wall Street:  “Don’t fight the Fed.”

The Federal Reserve holds an enormous amount of power over the economy.  While the President is usually blamed for a bad economy and praised for a good one, the fact is that the federal reserve actually has significantly more power over the state of the economy.

Despite the name, the Federal Reserve is not an institution of the Federal Government.  The Federal Reserve is made up of a board of bank executives from around the country — the “Governors” — with one individual chosen as the Chairman.  The Chairman is chosen by the President and confirmed by the Congress, but the post is meant to be non-political.  The group meets periodically to discuss the state of the economy and any action that should be taken.  The power of the Federal Reserve over the economy is so acute that the discussions held during the meetings are kept in secret with notes from the meeting only being released several months after they meet.

Often traders will move the stock market up or down before the Federal Reserve meets based on what they expect the group to decide.  If the group’s decision surprises the market, the stock market will often move up or down several percentage points.  The announcements made by the Federal Reserve are purposely made rather vague since they know the power of their words.


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The Federal Reserve controls the economy through two levers, the Discount Rate and the Fed Funds Rate.  The discount rate (http://en.wikipedia.org/wiki/Discount_rate) is the amount that the Federal Reserve charges banks that borrow funds from it.  Generally, it is frowned upon for banks to borrow from the Federal Reserve directly and they generally get a scolding when they do so.  The exception is during the recent money crisis where borrowing from the discount window was encouraged since other sources of capital had dried up.

The Federal Funds Rate (http://en.wikipedia.org/wiki/Fed_Funds_Rate) is the rate at which banks loan each other for overnight periods.  The Federal Reserve does not control the Fed Funds rate directly, but instead adds money to the economy or takes it away to affect the rate.  This is done by selling notes, which has the effect of removing money from the economy, or buying notes, which injects money into the economy.  Like anything else, the more money there is in the economy to lend, the lower the price for borrowing (therefore the lower the interest rate).

Because the bank’s costs of capital decrease when the rate at which they can obtain decreases, they also tend to lower the rates they charge.  This trickles up into the economy (except, interestingly, credit card rates), such that most rates tend to fall.  Because the rate savings accounts provide drops, bonds become more valuable, so their price tends to rise, dropping the amount of interest they provide.  Likewise, because the return of common stocks becomes more valuable, stock prices also tend to rise.

This is the reason to not “fight the Fed.”  When the Fed is lowering rates, it’s best not to be short, and when the Fed is raising rates, it’s best to prepare for a fall.  Note that in the early ’90’s, the Federal Reserve lowered interest rates to bring the economy out of the early 90’s recession.  The stock market took off first, followed by the economy.  President Clinton was credited with the good economy that followed, but it was all touched off by the Federal Reserve.

In the late 90’s, when inflation was starting to pick up and internet stocks were trading at ridiculous prices, Fed Chief Alan Greenspan warned of what he called “irrational exuberance.”  The Fed began raising rates to pick the ensuing bubble.  A few months later, the bubble burst and the early 2000 recession occurred.  President George Bush Junior was blamed for this recession, but the stock market had already started to fall before he took office because of the actions of the Federal Reserve.  Finally, just before the latest recession, the Federal Reserve, concerned about housing prices, began to raise rates to dampen the economy.  This caused the housing bubble to burst, leading to the current state.

The action of the Federal reserve typically takes half a year to have an effect.  It takes time for companies to start borrowing and hiring after rates are lowered.  Likewise, when the economy has a good head of steam it takes time for the wheels to grind to a halt.  The Federal Reserve set rates at near zero in 2008 and had been waiting for the economy to pick up.  It appears that there has finally started to be some growth, and the Feds are starting to slowly raise rates because they fear inflation picking up.  As they do so, it is likely to slow the economy and may cause stocks and bonds to fall, at least temporarily.

It would not be wise to fight the Fed.  If you have money invested that you need within a couple of years, it might be wise to take opportunities to sell.  If you are invested long-term, however, it would probably be better to just stay put.  You don’t know if the effects will be immediate or if there will be a great run-up through this New Years’ season as there often is.  If President Trump is able to get a tax cut through, that will also add fuel to the fire and you might miss out on a great advance in stock prices before the Fed’s effect is finally felt.  The effects of the Fed are temporary and matter little if you’re investing for 20 years.  Missing a big move up in stocks because you’re sitting on the sidelines will.

Have a question?  Please leave it in a comment.  Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Is It Possible to Save for College?


About 16 years ago I sat down and predicted the growth of my son’s college savings account.  I was planning to put away $2,000 each year into an Educational Savings Account (ESA).  Using an investment calculator, and using an estimate of a 12% return (about the average return for the stock markets), I predicted I’d have about $140,000 by the time my son was ready to go to college.  With in-state tuition at about $12,000 per year, plus money for food and housing, I was figuring a cost of about $30,000 per year, so the ESA would at least get him through undergraduate school.  He could then do research/teaching/etc. to help fund grad school if he went, and hopefully get out debt-free or fairly close.  That was the plan.

              

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Unfortunately, then came the 2001-2003 stock market, where returns were low or negative.  Things finally picked up after the 2003 tax cuts (yes, tax cuts do spur the economy, despite what some Liberal pundits will tell you), but then stocks fell during the 2008 housing market crash.  Since that point things grew at a modest pace, until Trump was elected, from which point on things have been on fire.  Despite the fairly good markets from 2009 – 2016, and the great market over the last 10 months, my annualized rate-of-return has been around 3.5% instead of 12%.

So, sitting here with about two years until the first tuition bills come in, my son’s account has a little over $52,000 in it today, instead of the $108,000 I predicted.  This is enough to pay for about two years’-worth of college expenses, but not four.  Alternatively, it is enough to pay for tuition, but not for room-and-board.  This has left me with a big dilemma:

How should I invest for the next couple of years, if at all?

With less than two years remaining, if I really need the money in two years, I should really put it all into bank CDs.  I cannot predict what the markets will do over such a short period of time, and they have about a 1/3 chance of being lower in two years than they are today,  There is a small chance, maybe one in ten, that they will be 25% lower or more, meaning I may only have around $39,000.  Then again, if we do see some great returns over the next couple of years, for example if Trump is able to pass big tax cuts and spur the economy, I could get 20% returns and have almost $75,000 when the first tuition bill arrives.  Note that my original predictions assumed I stayed fully invested in stocks the whole time, which was probably a bad assumption due to the risk of doing so during the last couple of years.

Another question this raises, however, is

Is it possible for a middle-class family to really save up and pay for college?

Granted, perhaps we should have been putting $4,000 or $5,000 away each year, with $2,000 in an ESA and then the rest in taxable accounts or a 529 plan after we maxed out the ESA.   But I don’t see how most families who don’t make $150,000 per year could afford that.  I mean, we have been very disciplined compared to many people our age.  Despite having an income far less than $150,000 per year, we paid off our home about six or seven years ago, leaving a lot of free cash flow available that many families who keep a constant mortgage don’t have.  Frankly, I don’t know how families who keep a mortgage are able to pay for the things they buy.  (Maybe they don’t, since the median amount of debt families who have a credit card balance is $17,000, according to Nerdwallet.)  Paying for everything and not using credit, including the things that come up like medical bills and auto repairs, I’m really glad we don’t have that $1,000 or $1500 mortgage payment each month.

I do think that many families should be able to get their children through college debt-free or close to it, but saving up everything ahead of time may not be possible.  Once our son gets into college, we could direct some of our regular income towards his room-and-board.  He is also likely to get scholarships that will cover most or all of his tuition.  If he also gets a part-time job and makes $500 per month, that would cover about half of his room and board.  Still, it does make you wonder why college prices are so high that many people need to get loans to get through.

Luckily in our case (and good planning and hard work create luck), we have some resources beyond the ESA to help pay for college.  Because of this, I will probably keep the ESA fully invested in stocks, hoping that we’ll see a couple of good years to boost the account balance.  If we see a drop in the next couple of years, we can cover costs with other funds for the first year or two while we wait for the ESA to recover a bit.  Really we don’t need to assume we’ll need to tap the account right away.

So what do you think?  Is it possible for families making $80,000 per year to save up for college?  Are tuition costs worth the value of the product they provide?  Is it worth it to run up loans to pay for college?

Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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