At the Bonneville Salt Flats in Utah, I struck up a conversation with someone who had cobbled together a car out of what looked like 50-gallon aluminum drums welded together -- with a bubble windshield on the front and a huge engine on the back. Expecting to exceed 200 miles per hour, he was applying duct tape to a wing to improve his car's aerodynamics. "Bear in mind," he said, "Everything I know about aerodynamics I've learned by extending my hand out the window of a moving car."
The ease with which we can absorb some investment history amounts to nothing much harder than tilting a hand in the wind. Yet ignoring history prompts some people to make disastrous mistakes. Recently, I learned of a couple who had hired an extremely experienced investment counselor about 10 years ago who advised them, during the crash, to stay invested. They couldn't bear to do it, and repeated the same mistake they had made during the 2000 crash. They sold at the bottom -- again. What remains of a retirement nest egg has now flatlined -- sitting in cash earning nothing.
As we head into what could clearly be a long-overdue market correction, it may help to dust off some stock market history. Since 1994, the S&P 500 index, including reinvested dividends, has averaged 9 percent per year. Adjusted for inflation, the gain is 6.48 percent, so the profit is real. Further encouraging is the fact that during the 20-year time period, we have experienced two major crashes -- the latest being the worst in 70 years.
In a conversation that never happened, F. Scott Fitzgerald supposedly said, "The rich are different than you and me,'' to which Ernest Hemingway, according to the myth, answered, "Yes, they have more money.'' To some extent, we all fall into some version of this distinction, because there are two types of money in our portfolios. There is what we have accumulated to date -- "Old Money." Then there are new future contributions -- "New Money."
"Old money" is what we will call our existing account balance in all retirement plans combined. "New money" will be the contributions we make over the next 20 years.
To go back to the future, let's assume we had $200,000 in a combination of IRAs, 401(k)s and other retirement accounts (husband and wife combined) back in 1994. Since then, we have been contributing a total of $10,000 per year into retirement plans -- money from all sources including employer contributions and two spouses contributing.
The original $200,000 invested in any S&P 500 index fund would have accumulated to $1,151,415 during that 20-year period, averaging 9 percent per year. (All these numbers are linear or proportionate, which means that $20,000 back then would have grown to $115,141, etc.)
Meanwhile, the $10,000 per year of new inbound money would have accumulated to $488,464. Again, everything is linear so $5,000 per year would have become $244,232, etc.
This past 20 years includes events that are as bad as things can get. Two wars in the Middle East, a collapse of the dot-com bubble, a collapse of the financial services industry and two government shutdowns. Moreover, if we consider the 114 years since 1900, Warren Buffett points out that during that long stretch of disasters, the Dow Jones industrial average rose from 50 to 17,000.
Let's take what we have today and project out for the next 20 years. Assuming things are just as bad as they've been for the last two decades, we can reasonably anticipate a mirror image of the same total gains outlined above -- but in proportion to what we have now and expect to contribute.
Predicting the future of economic and stock market events is relatively easy as long as we have a reasonable time frame of 10 years or more. Considering that at least some stock exposure is required throughout retirement to protect against inflation, we are all long-term investors to a degree. So an index fund and some knowledge of history can keep it very simple. It's the financial equivalent of sticking your hand out the window of a moving car.