Chapter IV
Important notes
Note #1: Things change
At some points in this book, I’ve cited various laws and regulations, and used specific numbers for things like the expense ratios of mutual funds, tax brackets, limits on contributions to investment accounts and the like. While these were all accurate at the time of writing, like many things in this world they are subject to change. Indeed, frequently during the various rewrites of the manuscript I found myself having to update them.
By the time you read this book, some will surely be out-of-date. As they are used primarily to illustrate the broader concepts I am presenting, this shouldn’t matter much. However, if you find for your situation or even just for your own curiosity it does, by all means take the time to look up the most current rules and numbers for yourself.
Note #2: On the projections and calculators used
in this book
In Chapters 3, 6, 13, 19, 22 and 23 you will find various “what if” scenarios.
In creating these, I had first to select a given calculator and then the parameters to enter. By definition, this means these scenarios are only for the purpose of making or demonstrating a point. While the data and input are accurate, the results are not, and cannot be, a prediction of what the future will hold.
In each case, the URL for the calculator used is provided along with the settings chosen. For example:
1. http://dqydj.net/sp-500-return-calculator/ (Use: Dividends reinvested/ignore inflation) 2. http://dqydj.net/sp-500-dividend-reinvestment-and-periodic- investment-calculator/ (Click “Show Advanced” and check “Ignore Taxes” and “Ignore Fees”) 3. http://www.calculator.net/investment-calculator.html (Click “End Amount” tab)
In running these scenarios, I chose:
To select “Dividends reinvested” because this is typically what investors do (and should do) while investing to build their wealth.
To ignore inflation (too unpredictable), taxes (too variable between individuals) and fees (also variable and if you choose the index funds I recommend, minimal).
If you want to see what the numbers look like including any of these variables, I encourage you to visit the calculators and run the numbers with your own specifications.
Most often in running these scenarios, the period of time I’ve chosen has been January 1975 - January 2015, for these reasons:
It is a nice, solid 40-year period and this book advocates investing for the long term.
1975 is the year Jack Bogle launched the world’s first index fund and this book advocates investing in index funds.
1975 happens to be the year I started investing, not that this matters to you.
As it happens, from January 1975 - January 2015, using the parameters I chose above, the market returned an average of 11.9% per year. As you’ll learn reading this book, the actual returns for any given year were all over the place. But when the dust settled, over that 40-year period, the average was 11.9%.
That is a breathtaking number.
Already I can hear the naysayers howling: From January 2000 - January 2009 the market wasn’t returning anywhere near 11.9%. True enough.
Returns then were an ugly -3.8% with dividends reinvested. But that time frame encompassed one of the very worst investment periods of the last 100 years.
During one of the best, January 1982 - January 2000, returns blew past 11.9%; averaging around 18.5% per year. More recently, since January 2009 until January 2015 the return has been 17.7% per year.
The fact is, in any given year, it is exceedingly rare that the market will deliver any specific return. Moreover, the average market return will vary dramatically depending on exactly what period you choose to measure.
So, this left me with a bit of a dilemma. The real, actual return for that 40-year period was 11.9%. But, and let me be absolutely clear about this, in no way should it be used as an expected return going forward.
I am NOT for a moment suggesting that you can count on 11.9% annual returns in planning for your future.
The idea that someone might think I am gave me serious pause.
So I considered using a different time span. But given the variables above, that would only project a different percentage equally unlikely to hold going forward.
Using the same 40-year span but with different parameters was an option. Those results look like this:
Without reinvesting dividends: 8.7% Without reinvesting dividends + inflation: 4.7% Reinvesting dividends + inflation: 7.8%
But for the reasons mentioned above these seemed even less useful, even if less shocking.
I briefly considered just using a random percentage that seemed reasonable, say 8%. Indeed, as you’ll see, I do use 8% in a couple of illustrations. It is commonly said the market returns between 8-12% annually and for those cases using the lower end of that range seemed most reasonable. But still that’s just pulling a number out of the air and who is to say what’s “reasonable”?
In the end, as you’ll see, I mostly went with the breathtaking 11.9%. As they say, it is what it is. But, and again,…
I am NOT for a moment suggesting that you can count on 11.9% annual returns in planning for your future.
We are only doing a bit of “what-if” analysis here to explore the possibilities. If 11.9% strikes you as too high—or too modest—you can run the numbers using the percentage or time period that seems most reasonable to you.
Whatever you choose, it won’t be what happens each year even if it turns out to be reasonably correct in measuring the decades. Nobody can predict the future precisely, and that’s something to remember any time you are looking at exercises such as these.