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Build Wealth In Any Market

Contributed by mm | August 17, 2004 10:21 AM PST

No matter whether you are a pro or a newbie in investment, you may find this Money Magazine article informational, thoughtful and, maybe, alarming.

The article tried to put the common belief that stock market, in the long run, consistently gives out an annual return of 8% - 10%. To put this into perspective, the article cites a research from finance professor Roger Ibbotson of Yale on stock market returns between 1926 and 2003. The conclusion:

- The nominal return stock market delivered throughout the period is 10.4%;
- Backing out inflation, investors only got 7.4%;
- Adding transaction costs (brokerage or management fees), the return dives to 5.9%;
- And individual investors tend to send more cash to the market in rising market and retreat during downturns, allowing this bad market timing to decrease return further to 4.6%;
- Government takes a cut of capital gain tax, leaving merely 2.4% to you.

The suggestions offered by the author are also helpful and should apply to majority of us:

- Control Your Costs: Reduce transaction costs, get low-cost index funds, have a tax strategy and don't time the market.

- Invest in the World: Diversification does not hurt.

- Search for Value (you know I admire Warren Buffett and only buy cheap stocks)

- Buy Bonds

- Think Big (actually he is trying to say think holistically)

A footnote: Back in March, my reading of Valuing Wall Street convinced me that we have a shaky road ahead and the stock market return can be much worse than in the last twenty-some years, which is not a good news for me whose early retirement plan depends a lot on investment returns (on top of savings). If you believe the most recent q-ratio data, S&P 500 can drop another 30% to reach fair value.

Another footnote: This is the 501st entry in PFBlog.com. A nice milestone, isn't it?

This Post Has Received 1 Comment. Share Your Opinions Too.


TRO Commented on October 27, 2004

Diversification and value are very important aspects to investing but keep in mind those returns from Ibbotson's study were averaged....that means annual rates fluctuated greatly from year to year.

One way to smooth these fluctuations to reduce risk is to employ asset allocation...think of it as diversification on steroids. By investing small portions of your portfolio into multiple investment classes (stocks - US and global, bonds - US and global, real estate and commodities), you can ensure a much smoother growth rate and avoid trying to time the market by adjusting stock/bond/money market positions.

I've written a few articles about how to use mutual funds for a very effective asset allocation strategy...check it out.


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