The sub-prime mortgage crisis of 2008-2009 is still fresh in most people’s minds. The lasting memory of that recession is so strong, in fact, that many people still refuse to invest back into the stock market today. As they like to think, “don’t play with fire, or you’ll get burned!” And once you’ve been burned before, you know to never touch that HOT stove again!
While it makes sense for a young person to first build up a solid foundation of liquid assets (e.g. emergency fund) when starting out their career, once this is in place, one needs to focus their attention towards building up a nest egg for that “better and brighter future.” If we shun the stock market entirely, what alternatives can we turn to that will help us accomplish this enormous task?
Savings Accounts and CD’s
Those who are trying to amass wealth for the long haul know that the secret to growing money is to let time and compound interest work its magic. A quick internet search will show that most savings accounts are currently yielding at right around 1%.
Compound interest is a powerful equation that we can use to help us generate phenomenal returns. But with an interest rate of just 1%, you’ll need a time-frame close to infinity to realize any significant growth. Even if you were to start with $100,000 today, with an annual yield of only 1%, you would need over 230 years of compounding to reach $1 million. Clearly, even the tastiest baked pie in the world is not worth waiting that long for!
If you think you might have better luck investing with CD’s, think again. Typical 1-year CD’s are currently yielding at an abysmal rate of less than 1.20%. For all the inconvenience CD’s provide, the fractional percentage points gained in yield make them not worth the hassle.
T-Bills, T-Notes, and T-Bonds
Treasury Bills (T-Bills), Treasury Notes (T-Notes), and Treasury Bonds (T-Bonds) have a reputation for being safe investments. After all, these are securities issued by the government and backed by the full faith and credit of the U.S. Treasury. If you can’t trust the government to repay you back your money, who can you trust?
The problem with these investments are again, related to yield. T-Bills are safe, so safe, in fact, that their yield amounts to less than 0.5%.T-Notes are a bit longer term than T-Bills, but even a 10 year T-Note yields under 2%. The longest maturity security is the 30 year T-Bond, and even that is yielding at only 2.81%.
With such paltry returns as these, investors will be hard-pressed to keep up with inflation, let alone think about building up a sizable portfolio. Treasury notes appeal to investors who seek: safety, stability, and low volatility. However, with an emergency fund already secured, and a long time horizon to work with, these benefits are of little importance to a young investor seeking to maximize growth.
Clearly, more offensive firepower is needed if we want our returns to really take flight.
What About Gold?
Many investors, who shun stocks, often turn to gold as a viable investment alternative. Though it is true that the capital gain returns on gold have been outstanding in recent years, one should also realize that gold is a fixed commodity. As the Oracle of Omaha, Warren Buffett likes to say, “if you own one ounce of gold for an eternity, you will still own one ounce at its end.” Gold offers no potential for rapid growth, as it is a sterile entity that cannot have offspring.
So, if gold cannot multiply, how can we expect it to compound? The short answer is, we can’t. Gold won’t be laying any eggs for you, so you can forget about enlisting its children and grandchildren to work for you.
So, a traditional savings account, CD’s, and treasury notes offer lousy yields. Gold, on the other hand, can only offer capital appreciation. So, what other investment options are there? What will help us to reach our final destination point?
Stocks really aren’t as unsafe or scary as one might think. To alleviate risk, many people decide to invest in an index fund.
When analyzing graphs, it’s true that if you focus on the short-term “noise”, you will get lost in a dizzying sea of madness. Prices go up, prices go down. The trick is to simply ignore the day-to-day fluctuations. When we step back and look at the full picture, we will see that the stock market performs extremely well over long periods of time (use the Stock Wizard to view performance data).
The S&P 500 index tracks the top 500 companies in the U.S. market. From 1990-2012 (January Prices), the compounded annual growth rate (CAGR) was an astounding 6.49%! Now that’s a yield worth getting excited about! If we plug this number into our calculator, we will find that we can reach the $1 million mark in just 37 years. This is a drastic improvement over the 230 years you would need from a traditional savings account, wouldn’t you say? Stocks can be a great investment over the long term, however, you can get hammered with fees depending the brokerage account that you use. Check out this Etrade review if you don’t already have an investment account or if you want to just get a basic understanding of how you are already invested, check out my Personal Capital Review.
In contrast to gold, when you buy a share of stock, you are actually buying ownership into a living, breathing corporation. Over time, these companies will release more products, gain more customers, increase earnings, acquire other companies, etc, and grow. As an invested shareholder, you no doubt are entitled to all the perks and benefits of this success.
Many companies are also willing to share the profits with you, and reward shareholders in the form of dividend payouts. This is the critical component really needed to supercharge returns. So, not only does the share price increase in value, but the dividends earned can also be reinvested each quarter, or year, to buy more shares. By employing this strategy, a shareholder will quickly accumulate a large number of shares over the years. The story of Anne Schieber is a popular tale of a woman who worked at the IRS until retirement, invested $5000 into stocks in 1944, and upon her death at the age of 101 saw her assets balloon to upwards of $22 million. How’s that for a return on investment?
If we re-examine the S&P 500 index, and account for dividends, and the re-investment of those dividends, our total return jumps to an even more staggering number, over 8.5%.
Here’s a graph showing the growth of $1 invested in the S&P 500 from 1950-2010. Displayed on a logarithmic scale, the orange line shows the total return (including dividends) vs. the blue line, which shows just capital appreciation:
The most recent stock market crash of 2008-2009 caused many investors a lot of short-term anguish. But the market is resilient, and has proven to be a worthwhile investment vehicle over the long haul. It would be foolish for any prospective investor who wants to strike it rich by the time they retire to pass up on the opportunity to invest in stocks, especially in favor of low-yielding alternatives, like CD’s and savings accounts. If the S&P 500 stays true to form and can generate total returns of 8.5% over the next 22 years, a lot of folks will be riding off into the sunset with a big smile on their face.
FI Fighter is an early financial independence seeker who aims to get there by 37.5. This day will arrive when the passive income and semi-passive income streams bring in more each month than is needed to pay bills. Let the journey continue!