Chapter 4

The average investor has made less than 2 percent per year on his retirement nest egg.

Yes, you read that correctly: less than 2 percent. In order to sell books and other products, many financial experts promote the fact that anyone can make 10-15 percent per year on their money. This type of propaganda has only made the retirement crisis worse, while lining the pockets of the very authors and financial experts who promote such wild claims. David Bach, author of The Automatic Millionaire (Crown Business, 2005), says that you should pay yourself first. To do this, you should have an automatic investment plan. Bach says you should deposit the first hour of your weekly paycheck into your 401(k),IRA, Roth-IRA, or other savings vehicle, then pay your bills with the rest of the paycheck.

You should also have your monthly expenses automatically deducted from your bank account, helping to make sure that bills are paid on time. This is the same author who introduced the world to getting rich by not drinking expensive coffee. Readers were told that by giving up lattes, they could save approximately $5 a day. He claimed that readers who invested that money at 10 percent, would amass millions of dollars. David Bach also writes about a woman who was spending $1,100 per month on expensive coffee and manicures. If over the next 30 years, she invested that $1,100 into her retirement nest egg, he claimed she would amass $2,700,000. That number seemed high to me, so I calculated the interest rate. She would have to earn AN ACTUAL 10 percent EVERY year on her $1,100 per month – not an AVERAGE of 10 percent per year — in order to have $2,700,000 in thirty years.

Face the facts! If you were able to earn 10 percent on your money every year, you wouldn’t be reading a book that shows you how to take control of your finances. You would be a very smartinvestor and probably very wealthy. Don’t take it personally! Even the best money managers can’t get 10 percent every year. If traditional pension plans, which are managed by professional money managers, were able to get an average of 10 percent per year, they would not be in the trouble they’re in. Realistically, it’s very hard to get 10 percent EVERY year.

So if you saved $1,100 per month and invested that money at 5-7 percent, in 30 years you would have approximately $900,000, which isn’t bad. I would rather have $900,000 than nothing at all. So why does David Bach use the 10 percent figure? Because $2,700,000 seems sexy, and because most people will just take his word for it. Saying you’ll make $2,700,000 by not drinking coffee sells books and gets you on TV shows like Oprah. If he said that saving $1,100 per month would result in $700,000 – $900,000, that figure wouldn’t motivate you to buy his book as much as the higher figure.

Such claims by so-called “financial experts” fuel the retirement crisis. The question is whether or not such exaggerated returns are achievable. According to DALBAR Inc., a financial research firm, for the 20 years that ended on December 31, 2008, equity, fixed income and asset allocation fund investors had average annual returns of 1.87 percent, 0.77 percent and 1.67 percent, respectively. The inflation rate averaged 2.89 percent over that same time period. Thus, over the last 20 years, the average investor invested in equities has averaged less than 2 percent per year – a far cry from the experts who say that people can earn more.

The DALBAR studies have consistently shown a large gap between the returns investors actually earn and the total returns for the fund. Simply put, the returns reported by mutual funds aren’t what the average Joe actually earns. Why not? First of all, people make less than what is reported by mutual funds because of their emotions. If people see the market going down, they start to panic. Their initial reaction is to get out of the market and go into hiding. Then, when the market starts to rebound,they are hesitant to get back in until the market goes higher, so they miss out on the gains when the mutual fund rebounds, and make less than what the mutual fund reports. Another reason people make less that what’s reported is that they are chasing returns. Financial magazines like to say that they list the best mutual funds to invest in. Since these lists tend to come out every six or twelve months, every few months people are buying the hot mutual fund. When the hot mutual fund doesn’t perform as expected, or another magazine touts an even better fund, people rush to buy in.

In the 1950s, investors bought shares in mutual funds and held them. According to the January/February 2005 issue of the Financial Analysts’ Journal, the average fund investor held his or her shares for 16 years. Today, for a variety of reasons, investors hold their investments for less than a year. In 2005, the average holding period for a stock was between nine and ten months, according to Fool.com. Regardless of the reason, people are not buying and holding mutual funds, the way their parents or grandparents did. Yet people like Dave Ramsey, author of Total Money Makeover (Thomas Nelson, September 11, 2003), seems to think that people can get 12% per year in your portfolio by holding your investments for a long period of time. In Total Money Makeover Ramsey states,

“Sadly, many intelligent but ignorant people seem to think that 12% rate of return on your
money in a long term investment is impossible.”

Ramsey also says that, “The S&P 500 has averaged 11.3% per year for the last 70 plus years.” Plus Ramsey says that he has purchased an investment that has average 12.78% per year since 1934 and one that has made 15.43% since 1959. In Total Money Makeover, Ramsey puts the critics in their place by saying, “So don’t let anyone tell you that you can’t predict a 12% return.”

People like Dave Ramsey are correct that buying and holding is usually a better strategy. Those who bought and held the Growth Fund of America earned, on average, 14.2 percent over the last 24 years. This leads financial experts to assume that high rates of return are possible. All of our retirement planning is based on the fact that we are going to make double-digit returns. Yet financial experts don’t factor in that human emotions could get the better of us. In order to achieve the high double-digit returns, people must overcome their fears during the bear markets and resist the urge to buy the “hot” mutual fund. They would need to become unemotional about money, and realize that not only do markets go up and down, but that today’s “hot fund” may be tomorrow’s worst-performing investment. Many people can’t discount their emotions or their desire for the best when investing.

People like, author and radio show host Dave Ramsey create the illusion of prosperous golden years, yet the reality is that people aren’t making 12-14% in their investments, they’re making closer to 1.87 percent, thereby delivering a future society of retirees who live in poverty and don’t have enough money to afford basic essentials like medicine, food, and transportation.

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