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All The Professional Investment Advisors Got It Wrong!

The most important investment advice I ever received is "Never lose any money!"

Yes, that may sound simple and silly, but it is sage advice if you think carefully about it and the value of compound growth and the future value of a current dollar. A dollar lost today is far more than a dollar. Lets look ....

The almost universal consensus among Professional Investment Advisors is that as you near retirement you should shift your portfolio allocation to more and more conservative holdings. This advice is based upon the reasoning that you have less time to recover from an adverse event since you are at or near retirement and thus the loss will not have time to recover. In my capacity as a petroleum exploration and development geologist and Chief Operating Officer of Oil and Gas for a Fortune 200 scale company. Risk management is NOT the same as risk aversion. Far more goes into the decisions and choices of portfolio management.

Reasoning by financial managers ignores two very important facts, A) the value of compound earnings and B) that even at retirement, the typical investment horizon remains another 25 years and thus allows time to recover from market volatility as much as at any other investing time.

The long term compound annual growth rate for the S&P 500 index is 9.34 %. In plain English, this means that historically an investment has doubled about once every 8 years. Thus an investor starting out with $1 invested at age 18 will find that 50 years later they have $86.89 at retirement age of 67 if they do nothing more than simply let that $1 sit and compound at historic rates.

Now, if our investor is frugal and disciplined and invests an Additional $1 each year, the results are $ 1,006.44 awaiting them at retirement.

If we crank the contributions up to the very reasonable budget of lets say $ 1,000 per year then our investor has a few dollars over $1 million ($1,006,444.93) to enjoy at the start of retirement. Keep in mind, this is the average compounded return, including good markets and bad, bubbles and crashes. The 9% annual rate of return holds for periods of 15 years and longer. Shorter periods show greater volatility in both directions. However, even the retired (post 67 year old) investor still can be expected to be around into their 90s these days and much of their investment still working and compounding for them. Thus even at 67, a very large part of the retiree's total portfolio continues to enjoy a 15 year plus window and the anticipated 9% + average returns.

In fact, The Pro's got it 100% backwards. It is not when you retire that you should be more conservative with your investments. No! It is when you are young! As shown above, that $1 invested at 18 will be $87.00 !!!! So, every $1 dollar they lose at age 18 is really like losing $87 dollars at age 67. Yes, you must be 87 times more cautious at age 18 than at age 67. and 174 times more cautious than at age 75, and 348 times more cautious than at age 83. Goodness, at age 91 you can take on 696 times more risk as you did at age 18 and still have the same net risk result as having lost $1 at age 18!!!!

S&P 500 Total annual returns

 

 

 

Year Annual
Return
$1.00 Investment
at the start of '88
Gives
5 Year
Annualized Return
(g/i)=(1+ar)^5
10 Year
Annualized Return
(g/i)=(1+ar)^10
15 Year
Annualized Return
(g/i)=(1+ar)^15
1988 16.61% $1.17 - - -
1989 31.69% $1.54 - - -
1990 −3.10% $1.49 - - -
1991 30.47% $1.94 - - -
1992 7.62% $2.09 15.89% - -
1993 10.08% $2.30 14.55% - -
1994 1.32% $2.33 8.70% - -
1995 37.58% $3.21 16.59% - -
1996 22.96% $3.94 15.22% - -
1997 33.36% $5.26 20.27% 18.05% -
1998 28.58% $6.76 24.06% 19.21% -
1999 21.04% $8.18 28.56% 18.21% -
2000 −9.10% $7.44 18.33% 17.46% -
2001 −11.89% $6.55 10.70% 12.94% -
2002 −22.10% $5.10 −0.59% 9.34% 11.47%
2003 28.69% $6.57 −0.57% 11.07% 12.19%
2004 10.88% $7.28 −2.30% 12.07% 10.91%
2005 4.91% $7.64 0.54% 9.07% 11.51%
2006 15.79% $8.85 6.19% 8.42% 10.65%
2007 5.49% $9.33 12.83% 5.91% 10.48%
2008 −37.00% $5.88 −2.19% −1.38% 6.46%
2009 26.46% $7.26 −0.06% −1.19% 7.87%
2010 15.06% $8.35 1.80% 1.16% 6.58%
2011 2.05% $8.52 −0.75% 2.67% 5.28%
2012 16.00% $9.88      
High 37.58%   28.56% 19.21% 12.12%
Low −37.00%   −2.30% −1.38% 5.28%
CAGR 9.34%        
Median 12.97%       10.92%
Click to enlarge

(from http://en.wikipedia.org/wiki/S%26P_500 )

There are indeed risk and volatility management options that every investor needs to consider for their retirement portfolio at various points along the path, especially as you approach the year of retirement when new contributions to the funding may stop or curtail for many investors and withdrawals (income sourcing) begin. I will discuss some of these in my next article.