the math hurts

What is the name for what’s going on with the economy these days? We’re still technically not in recession and I think shrieks about a depression are overdone.  A crisis?  Whatever it is, it continues and I see no signs that it will abate before long.

I had managed to stay calm about the crisis even after seeing my investment and retirement accounts (IRAs) stagger. I work on Wall Street, so I’ve seen the bloodbath in the workforce – people who worked in accounting or IT who had nothing to do with the idiotic ponzi schemes got axed.  Times are tough, and from an objective viewpoint I understood that.

Here’s what brought it home for me. I have a 401(k), and the company it’s with has a nifty little feature to calculate “real” return; returns with the matches, contributions and so on factored out so you only see the return on what was in your account.  Up until 2008 I had been running at a slightly-disappointing-but-tolerable 8% per year return.

From my point of view 8% on a tax-free return is not a bad return, but in the heady market froth of the last few years it seemed less than exciting. I had managed not to worry too much about my 401(k), but I finally broke down and checked it Friday.  The result?  This year, down 65%.  My portfolio in my 401(k) is dull:  S&P 500 index funds, a midcap index fund and a euro-pacific index fund (plus I have a bit in stable value, about 5% of the total).

That alone wasn’t enough to bother me, but this was:  the standard assumption in the personal finance world, based on a lot of historical stats, is that a 10% per year return in the stock market is reasonable and expected for retirement planning purposes.  At first glance, that seems to be reasonable.  10%?  No big deal.  But here was the kicker, for me:  it takes 11 years to restore a 65% loss to breakeven at 10%.

I need to make 10% per year for 11 years just to get back to where I was in 2007. Is there another dot-com run-up somewhere in the future, when the market will surge 20%, 30%?  Keep in mind I’m talking about index funds, so the return is based on the market as a whole, not an individual stock where the possibility of a 30% rise is greater (although the possibility of a 100% collapse is also greater).

I’m not saying this to discourage anyone from investing in index funds, but it is a brutal reminder that you are not “investing” in index funds:  you are SAVING. I have some spare cash and I’m tempted to put it towards individual stocks rather than index funds when I look at those breakeven numbers.  11 years of great returns to break even?  Whee.  If you ever needed a reminder why you shouldn’t put ALL of your savings and investments in the market, thinking about the math on losses should be enough to keep you scared straight.  It takes a 100% gain to recapture a 50% loss…

photo credit: Petrick2008