Question Hour

As you know, all my listeners are welcome to call me directly if they have any questions - preferably related to their finances…

JO’s Question

One of my listeners, JO, recently called in with the following question:

My wife and I are concerned about saving for retirement. We are in our mid-30s and contribute to our 401(k) accounts. But it does not seem enough. We are concerned about our future and savings.

JO was particularly concerned that even though he had been contributing 8% of his salary to his 401(k) for about 10 years, the account had barely appreciated. In addition to 401(k), they had saved mid 5-figures and also put a small amount away for their 6-year old daughter’s college fund.

JO had an adequate 30-year term insurance and his wife had a small amount of life insurance.

Our Discussion

Were JO to lose his job, his mid 5-figure savings would be adequate as an emergency fund because it would cover many months of JO’s living expenses. Were JO to die, his life insurance would support his family without scaling back their lifestyle.

Now to his 401(k).

JO was understandably frustrated that he had been systematically stashing away 8% of his salary in a 401(k) account for 10 years and yet did not see his portfolio rise.

We are taught the benefits of investing over the long run. Isn’t 10 years long enough?

Well… yes, of course it is most of the times, but sometimes, it just isn’t.

Long-Term Market Performance

For example, in July of 1965 the S&P 500 was valued at 89.96, then fell till it reached a low of 63.54 in 1974, then recovered somewhat to 83.87 by July of 1975 - still down 10 years later.

By July of 1985, 20 years later, the index was at 182.08 - barely a 4% compounded annual return.

Today, of course, the index trades at around 1,200, equivalent to an annual increase of about 8% per year since 1985.

Such market doldrums also happened in the 1930-1950 period.

So what was I to tell this young man about the lack of a decent return over the past 10 years?

Two words… Hang On.

Something’s Growing

Fortunately for JO, with his job, emergency savings and life insurance, he doesn’t need his 401(k) money any time soon. Were it even to shoot up in value, he could do nothing immediate with it. Fortunate too that he can let that money grow over the next 30 years while adding to it yearly.

So even though his portfolio hasn’t appreciated over 10 years, his systematic 401(k) investing increases the number of shares he holds by 8% every year. This in itself is significant because only a modest increase in share prices will deliver sizable portfolio gains due to the higher number of shares.

But wait, there’s more. At age 30, 40 or even 50, JO should hope for terrible stock markets - the worse, the better! Sounds crazy, right?

But think about this - it’s far better to buy more shares at low prices than to buy fewer shares at higher prices.

Long-Term View

Share prices will likely recover over time, and JO’s annual 401(k) investments will add a significant kicker to his retirement portfolio with significant compounding.

So my advice was simple.

JO needed no new financial plan, nor any fancy insurance that guaranteed a princely sum. All he needed to do was stay with the program, continue to accumulate shares, keep it simple and keep it low cost - these easy activities plus the element of time will get him to his retirement goals.

Good luck, JO!

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Steven L. Pomeranz, CFP is a 29 year investment management veteran and host of “On The Money!” which airs on NPR station, WXEL in South Florida. He concentrates on serving high net-worth individuals and has been named one of the Top 100 Wealth Advisors 2007, by Worth magazine (October 2007 Issue), honoring America’s premier financial and wealth strategists.