Category Archives: Personal Finance

How Did Stocks Really Do in 2015?

How did your investments do in 2015?

Any of you who know me know that I am a big fan of investing in stock market index fund. These funds mirror the performance of the stock market as a whole and do not seek to pick and choose winners. Historically, most people who invest in index funds make more money than the people who try to gamble on the performance of a specific company or industry.

One of my favorite index funds mirrors the performance of the S&P 500 Index. The S&P 500 Index measures the performance of the 500 largest companies in the United States. Let’s see how it did in 2015 by way of examples:

In 2015, if you invested $1000 at the end of each month, you would have $11933.78 at the end of the year. In other words, you would have lost $66.22 out of the $12000 you invested.

Or… If you had invested $12000 on the first business day of January 2015, you would have had $11907.37 at the end of the year. In other words, you would have lost $92.63 out of the $12000 you invested. That’s less than 1%.

To put that in perspective, it is interesting to note that if you had sold such a hypothetical investment just 2 days ago, you would have gained more than 1% for 2015.

Remember that stocks are long term investments. It is normal for them to change day by day and from month to month or year to year. Economists have studied stock fluctuations for many decades and have found that there is no real pattern to day to day movements in stocks. If stocks go up one day, that does not mean that the economy is getting better. And if they go down one day, that does not mean that the economy is doing worse.

But, one thing we can say is that, in general, stocks increase in value over 10 or more years.

It is also important to remember that 2015 was the first year in 7 years that stocks went down over the course of the year. (And that was just barely). Where were stocks 7 years ago?

Well… if you had invested $12000 seven years ago, then you would have almost $18000 today.

Things are not so bad after all. And today begins a new year. Good things are in store for those who invest regularly in a diverse portfolio of investments.

How do I know? It has always been that way and there is no reason to believe that things are different now. :-)

Happy New Year!

Should I Pay a Loan Off Early?

Dear Jim,

I have a 5 year loan for a vehicle that I took out 4 1/2 years ago.  I have 6 months  left to pay and the balance is just over $2400.  The interest rate is 7.75%.  I also have $3000 in cash that I am thinking about investing.  Should I invest it or should I pay off my car loan?

A friend told me that I’ve already paid most of the interest on the loan and that, from this point out, it’s not worth paying off since I’m pretty much just paying principle at this point.

Chuck

Chuck, your friend is both right and wrong.

Assuming you haven’t made any extra payments along the way, it looks like you borrowed about $24000 to purchase your auto.  Over the past 54 months (4.5 years), you have paid about $5000 in interest.  But, if you keep the loan and finish making the payments over the next 6 months, you will only have to pay $65 in interest.  Your friend is absolutely correct that you have already paid the majority of interest on this loan.

However, it’s probably best to pay off the loan now.  Here are explanations of your two options:

  1. Pay the loan off now.  You will save $65 in interest.  Over the next 6 months, you can save ~$500 each month instead of making payments.  You’ll have $3000 in cash in 6 months that you can invest.  Even if you don’t get any interest on your savings over the next 6 months, you will have saved $65 in interest.
  2. Keep making payments and invest your $3000 in a safe investment like a CD.  You’ll pay $65 in interest on the loan.  If you look around carefully, you should be able to find a CD that pays 0.5% interest.  Bankrate.com can help you find the best CD rates.  But, at 0.5%, your CD will only provide you with $7.50 of interest income.  Depending on your tax situation, you could pay up to 26% tax (15% Federal plus 11% state if you live in Oregon or Hawaii) on this interest income.  At the end of 6 months, you will have $59. 45 less in your pocket.

It’s clear that the first option is usually better.

One exception may be in the case where you are among the 28% of Americans without emergency savings.  If you have no savings, it may be advisable from a psychological perspective to start building an emergency fund rather than saving the $65 by paying off the auto loan early.  You’ll still have $65 less at the end of 6 months.  But, often, people find it easier to borrow money rather than give up savings.  If you have savings, you’ll carefully think before you dip into it.  With no savings, however, it can be more tempting to label purchases as “emergencies” and charge them to a credit card.

No Longer Funding 401K?

On May 23, 2012, Yahoo Finance posted an article  by K. W. Callahan explaining why he is no longer funding his retirement account.  Here is a snapshot of Mr. Callahan’s article.

NoLongerFundingRetirement

Mr. Callahan has a business degree from the Indiana University Kelley School of Business.  Unfortunately, he seems to have forgotten much of what he learned in business school.  There are many misconceptions about the way the equity markets work.  But, this post concentrates on the power of dollar cost averaging and how Mr. Callahan has missed out on a significant opportunity to grow his retirement savings.

Mr. Callahan explains that he stopped contributing to his 401K in late 2007.  At that time, his retirement account balance was about $38000.  He correctly points out that his balance was only $33000 in late 2011 – almost 5 years later.

Assuming he makes about $50000 per year, a 3% contribution would have amounted to $125 per month.  If he had saved $125 per month in a non-interest bearing account, he would have added $7500 to his savings over the course of 5 years.  That would have brought his retirement savings today up to around $40000.

But, a better strategy would have been to invest his 401K in a diversified basket of securities reflecting the total market value, such as the iShares Russell 3000 Index Fund (IWV), and keep contributing.  If Mr. Callahan had done this, he would have had around $45000 as of June 1, 2012.

The reason is simple.  With regular contributions at set intervals, investors are able take advantage of low points in the market.  For example, purchasing $125 could have bought 3.15 shares of  (IWV) on February 2, 2009 — at the low point of the market.  A similar investment of $125 on April 1, 2011,  would have purchased only 1.56 shares.  Catching the up’s and down’s of the market by purchasing set amounts at regular intervals allows investors to accumulate more shares when prices are low and less shares when prices are high.   This is dollar cost averaging.

Obviously, there were months that such a strategy would have left Mr. Callahan’s account with less than $38000.   But, over a reasonably long period of time (years, or decades),  dollar cost averaging using a diversified basket of securities has historically produced much better yields than buying securities all at once and then holding them.  And it has produced better results than government bonds, real estate, gold, or other investments.

Dollar Cost Averaging
Mr. Callahan's Investment Alternatives

The lesson is to keep investing a set amount regularly in a broad range of investments.  Never give up.