John D Schultz

In America (and many other countries around the world), we’re taught to save, save, save for our retirements.  The primary vehicles we’re taught to use are the stock market and 401k plans (which are primarily invested in the stock market).  In the current economic times, it’s easy for me to say what I’m going to say, but the more I think about it, the more I think it’s true.

Imagine XYZ, Inc.  They are a large company that produces ABC.  They have a large employee base, and match 401k investments up to 5% with stock in XYZ, Inc.  So, the employee doing the “right thing” who makes $30,000 per year contributes 5% ($1,500) into his 401k and the XYZ, Inc. contributes an additional 5% ($1,500) in XYZ, Inc. stock.  The employee feels good because XYZ, Inc. has matched their contribution.  Yet, really all the company has done is given you a promissory note.  A promise to pay you whatever the price per share is when you come to collect.  There is no guarantee that the 5% match will be worth $1,500 when the employee begins to live off the 401k investment.  In fact, it may be worth much less.  Also in our scenario, let’s presume the employee is loyal and believes in the company he is working for who he works.  As a result, most of his contribution to his 401k is in stock in XYZ, Inc., because it’s a good company, and they’ve been good to him his entire life.

What has happened in that scenario?  The employee has taken 5% of his wages ($1,500) and given them back to the company for their use (by purchasing stock) without any guarantee of the return of the principal.  To entice the employee to do this, the company has said, we’ll match your contribution, because we believe it is important to fund one’s retirement – again a promise to pay with no guarantees.  It all sounds good, but the company is very much coming out ahead.  In effect, XYZ, Inc. is getting a 5% deduction in wages paid when you reinvest into XYZ, Inc. stock (of course, you can invest in other companies, but the overall effect is to reduce your take home by 5% and reinvest that into corporate America).  Plus the money is given interest free, without a guarantee of the return of the principal.  Where else do we give others 5% of our gross income interest free without a guarantee of return of principal and say it’s the American thing to do?  Banks don’t do it – no they secure their investment with tangible property.  Investors secure it with a piece of paper called a stock certificate.

Of course, the larger argument is that all things will increase in value forever, and your investment today will be worth much more in the future.  One only needs to look at how the This of course is the sound financial principle called inflation.  Of course the government and large companies argue that some inflation is good.  In the above example, the employee provides $1,500 in todays dollars, and maybe gets a return of $2,500 in future dollars.  Yet, when viewed against inflation, that increase (if there was even an increase and not a decrease) is minimal.  Take a peek at this excellent article to understand more about the real numbers of inflation at work on investments: DJIA (Dow Jones) Adjusted for Inflation.

From that article, comes this startling quote:

Over the past 10 years, the DJIA has increased from 9358.83 to 10825.17. That is fine and dandy. It appears that you have gained … until you take a closer look at the data. That represents an annual rate of return of only 1.47%. Inflation adjusted is -1.44%. That’s right, you have lost money! When you factor in a 1% fee for assets under management, and capital gains tax (currently at 15% of the 1.47% annual gain), you’ve lost even more … down to -2.66% per year LOSS!

The article goes on to look at figures for 40 years (…the DJIA has had an annual rate of return of only 6.28%, or rather 1.56% adjusted for inflation. Factor in the management fees and capital gains tax, and you still have LOSS … to the tune of -0.38% per year.), and 80 years (the DJIA has an annual rate of return of only 4.51%, which is 1.23% adjusted for inflation. Again, a total LOSS of -0.45% per year for 80 years!).

It’s true, a person can obtain good returns on investments in the stock market, but there is no guarantee of any return of principal, and when reviewed contextually with the rate of inflation, there is actually a stronger likelihood of minimal return of “true” principal.  An individual would have been much better off not gambling and simply putting the funds in an account that was paying interest at a rate greater than the rate of inflation.  The individual would have preserved the strength of his/her investment, and actually made a good investment!