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Wednesday, 28 October 2009

Bear Markets Do Wonders for Retirement

by Joe Mont

The six-month bear market that wiped out nearly half of Americans' retirement savings threatens to scare away the class of investor who has the most to gain from it: young people.

Mutual fund manager T. Rowe Price says in a study that those who began to systematically invest in equities in severe bear markets were "significantly better off 30 years later than investors who began in bull markets."

The analysis charted four hypothetical investors who each contributed $500 a month (15 percent of a $40,000 annual salary) toward a retirement account that replicated the S&P 500 Index over three decades. The starting date marked a severe stock-market downturn: 1929, 1950, 1970 and 1979.

The four investors were initially hard-hit. The S&P 500, for example, had an annualized return of minus 0.9 percent from 1929 to 1938, the second-worst 10-year period in history. The benchmark index grew a mere 5.9 percent in the recessionary era of the 1970s.

But for all four investors, there was good news to go with the bad: They had the opportunity to buy at low prices, accumulating more shares for what would be coming bull markets.

By the end of their first decade, the investors were poised to shake off market drops. The projections built upon 1950 and 1979 showed the greatest success. The S&P 500 returned an annualized 19.4 percent from 1950 to 1959, and 16.3 percent from 1979 to 1988, and their nest eggs swelled to $152,359 and $137,370, respectively.

The study makes its point in dramatic fashion by pointing out that a 30-year investment that began in 1929 ended with a total gain of 960 percent. The investor who started in 1970 fared even better: 1,753 percent.

By comparing the results with investors who began saving during bull markets in the 1980s and 1990s, the four investors did twice as well with their money.

"As counterintuitive as it may feel, it is actually a silver lining that the prices have gone down," says Stuart Ritter, assistant vice president of T. Rowe Price Investment Services. "For young investors still in the accumulation phase, it is better to have the bear market first, because then you buy a whole lot of shares at a lower price than when the bull market hits."

Ritter, who also teaches a class on personal finance at John Hopkins University in Baltimore, says the younger generation is starting to embrace that message despite rampant pessimism.

"They see older people panicking, and they understand why," he says. "But they are saying, 'Gee, 2008 felt bad and people worried about it, but I'm 22 years old and it's a long time before I am going to use this money.' It is a little bit easier for them to put 2008 in perspective, which I find interesting because, for their investing lifetime, 2008 represents all of it. But they are still pretty good at putting it in perspective and saying, 'It is just one year. I have a whole lot more ahead of me.' "

Ritter says it's a challenge to keep investors, young and old, from overreacting to bubbles and cycles.

"How do we change people's perspective from what happened in the past 18 months into the broader perspective that is appropriate for their goals and time horizon?" he says. "We see it at both times [bull and bear]. At the peak of the tech boom, all people see is that, 'Tech stocks always go up; why shouldn't I have everything in stocks?' With the real-estate boom, it was, 'Real estate has been doubling; why don't I have everything in real estate?' Then it was, 'Oh, no, 2008 was a disaster; why would anyone have anything in stocks.' It is just a different variation on the same theme. Our advice is to look beyond the short term and be appropriately invested for your time horizon."

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