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Friday, December 01, 2006

The Worst Investment Strategy

The Worst Investment Strategy

By James Freeman

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author's colleagues upon the staff of the Commission.

Should I invest my retirement savings in a mutual fund? What's the best way to select stocks for long-term growth? People naturally ask these questions when they meet the staff of the Securities and Exchange Commission's Office of Investor Education and Assistance. These are tough questions to answer, especially because, as the official referee of America's financial markets, the SEC rightly avoids rooting for particular teams. And no, we don't draft money managers to compete in a financial fantasy league.

However, while we can't tell you which investment option is the best, we're free to tell you which one is the absolute worst. We can also tell you which one is the second worst. Let's discuss that one first. The second worst investment strategy ever devised is to hand over your hard-earned savings to anyone, without first checking out the person's background and credentials. And checking out a potential investment adviser or broker does not mean simply listening to her describe how she shares your religion, ethnic background, and values. While those may be interesting things to know, you'll want to dig a little deeper. Every year at the SEC, we receive thousands of complaints of investment fraud, and while the victims who write or call us represent far less than one percent of the investing public, you don't want to be one of them.

The SEC's website has a guide to checking out the background and disciplinary history of brokers and advisers at Here you'll learn how to check our database of registered investment advisers, the NASD's broker database, and the information maintained by state securities regulators. The North American Securities Administrators Association website at can direct you to your state contacts, and also provides useful tips on avoiding scams. You can also call us toll-free at 1-800-SEC-0330. All of these resources should help you avoid the world's second worst investment strategy—being careless when selecting people to entrust with your money.

What could possibly be worse than that? Well, in fact, there is one approach that is even less likely to result in a secure retirement and financial freedom. While no one can guarantee the success of any particular investment, there is one investing approach that is guaranteed to fail. And sadly, it is an approach that we as a nation increasingly favor. This disturbingly popular option is to not save at all.

For reasons that are not entirely clear, America's savings rate has been declining for more than half a century, but since the spring of 2005, according to the Commerce Department, we've actually moved into negative territory. Not only are we as a nation not saving; for the last several quarters we've actually been spending beyond our income. For August and September of this year, personal outlays exceeded disposable personal income by more than $60 billion. This is really not a good time to hit rock-bottom -- or just below it, actually -- with our savings habits, given the expanding need for these savings. Thanks to advancing medical technology, we're all living longer, which means we will need to fund longer retirements. U.S. life expectancy inches up with each new report from the National Center for Health Statistics, and has now reached almost 78 years. For females, the news is especially bright – today's baby girls are expected to live to age 80, on average. Truly a blessing, and also a new financial challenge -- and it is not simply a challenge for retirement planning. According to the College Board, the average cost of attending a public college or university for just one year is over $12,000, and the average cost for just one year of private college is more than $29,000. These costs continue to rise faster than inflation.

Federal Reserve Chairman Ben Bernanke spoke recently on the need for increased personal saving, but lamented, "Unfortunately, many years of concentrated attention on this issue by policymakers and economists have failed to uncover a silver bullet for increasing household saving." OK, this may not be a silver bullet, but a look at the history of America's capital markets provides a very powerful reason to save today's income and invest it for tomorrow's wealth.

Over the last 80 years, long-term investors in U.S. stocks have earned, on average, a little more than 10 percent per year. For those not investing in tax-advantaged accounts such as 401(k) plans and IRAs, this works out to an average after-tax return of about 7% per year. There is absolutely no guarantee that this trend will continue, although, interestingly, the long-run real returns on U.S. stocks have remained fairly steady for a full two centuries, according to Jeremy Siegel of the University of Pennsylvania's Wharton School.

So, understanding that we cannot predict the future, let's look at what investing in America's equity markets has traditionally meant for U.S. investors. A person who managed to save $1,000, invested this money in U.S. stocks and also managed to leave it alone for 20 years would end up with more than $3,800, after taxes. If this investor could manage to avoid tapping into it for a full thirty years, the total would rise to more than $7,600. If this wise investor had the money in a tax-deferred account, her $1,000 would turn into more than $6,700 in 20 years, and a whopping $17,449.40 at the thirty-year mark. If our hypothetical long-term investor could step up and commit to saving and investing $1,000 in stocks each and every year, the long-run average says she would end up with almost $44,000 after-tax in 20 years, and more than $101,000 after thirty years. Using tax-advantaged accounts, the figures run to $63,000 and $180,000. All of these figures do not include broker or mutual fund fees, which you should watch carefully, as they can have an enormous impact on your returns. Still, history shows that for the average participant in the U.S. markets -- that's right, average, not lucky or exceptional -- long-term investing in stocks has meant enormous gains, even after paying taxes. Isn't that a great reason to save?

To help you get started please read "Get the Facts on Saving and Investing" which is available online at Or call us toll-free at 1-800-SEC-0330 and we'll send you a copy.

James Freeman is the Investor Advocate at the U.S. Securities and Exchange Commission.

[Piaw's Note: This article re-published with permission. I'd link to it, but I couldn't find it anywhere else on the internet.]

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