Does $97,000 Matter To You?

With the year 2018 in the books, we know the S&P 500, including dividends, has produced a meager 4.86% annualized return from the year 2000. That return has beaten inflation, but I call it meager because it’s not the 10% or so that many stock brokers, financial advisors, and market historians have taught much of the public to expect for such a long period of time. The return is way below its long term average, even if our starting point is a bit arbitrary and convenient (the start of the technology stock meltdown).

But there is another lesson to be learned from the past 19 years besides subpar annualized returns. The fact is those returns are radically bifurcated or back-loaded. In other words, they have accumulated recently or in the second half of the nearly two-decade period, not the first. And that means people in the age range of, say, 45-55, who have been investing by contributing steadily to work-sponsored savings plans like 401(k)s and 403(b)s for the past couple of decades, have been the beneficiaries of an amazing sequence of returns. It also means they may be unprepared for a less beneficial sequence in the future.

A way to illustrate this point is to compare a $95,000 lump sum investment in the S&P 500 TR Index in 2000 to a series of $5,000 annual investments from 2000 through 2018. Amazingly, the final dollar value of the periodic investments nearly equals the dollar value of the initial large lump sum.

If the compounding is steadier a large lump sum should outstrip periodic contributions because only a few of the contributions are getting the benefit of compounding for a long time. Only if the compounding is completely lop-sided, with positive returns occurring overwhelmingly in later years (which is what has happened), should these investments be nearly at the same dollar level. Another way of saying this is that, assuming reasonably even compounding, you should always want to invest a large lump sum immediately rather than dribble money into an investment over time. But the sequence of compounding over the last two decades has been anything but even or steady.

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