January 25, 2012

A Rate of Return You Can Actually Count On

Credit: Stuart Miles
I find it quite funny how many people I come in contact with think that financial advisors know what the stock market is going to do. I find all the people that claim they know what the stock market is going to do to be even funnier.  I would know what the stock market is going to do if I could only get a copy of the Wall Street Journal a day early. Even the best of the best stock-pickers are only making very educated guesses.

What I can tell you is that in the long run, the stock market is going to grow and go up because it always has. I can give you a bucket of frequently successful investment strategies to try. I can even tell you statistically that over long periods of time the stock market goes up an average of about 8% a year, but I can’t give you specifics.

In spite of acknowledging my crystal ball shortcomings and all the market fluctuations in recent years, I have good news. Today, I can tell you something you can do that will give you a rate of return you can actually count on. 

Do you have a school loan, car loan, furniture loan, or a mortgage? If you do, I can almost guarantee your rate of return; your interest rate.

Frequently people are focused on owning more houses, more property, more jewelry, and more cars. They want more cash and more possessions; essentially more assets. It is a relatively simple concept, but paying off debt (lowering your liabilities) is just as good to your financial position as putting it in the bank or investing it. At times, it can even be better.

Let’s say you have $100. You have three options: 1) Put it in the bank, 2) Put it in the stock market, or 3) Pay off your student loans.

1.       If you took option 1 and put it in the bank, in one year you would have earned approximately $0.50 because interest rates are so low (per Bankrate.com, Interest Checking Yield is currently .50%).

2.       If you took option 2 and put it in the stock market, in one year you would have something. As I stated earlier, neither I nor anyone else can tell you what you will have. It is my belief that the market is slowly recovering, but there are some more peaks and valleys to be seen over the next few years. So, let’s say you get ½ of that average long term return we talked about earlier (1/2 x 8% = 4%). That would mean you would have earned approximately $4.00.

3.       If you took option 3 and put that $100 towards your student loans, you would have saved yourself $6.80 because the current interest rate for student loans is 6.8% (per direct.ed.gov). You saved $6.80 because if you had not paid that $100 towards your loan, you would owe $6.80 more at the end of the year than you did at the beginning of the year.

So I ask you, would you rather make $0.50, $4.00, or save $6.80? Of course you and I would take the $6.80. However, there is that risk that the stock market might do better than we thought and earn more than that $4.00 or even our $6.80 we saved. All that being said, with so much international and market uncertainty, you should at least consider the value of going with a rate of return you can actually count on and use any extra cash you may have sitting around to pay towards any of your liabilities that have a relatively high interest rate.


1 comment:

  1. I wish you did get an early edition of the Wall Street Journal. Or at least had a working crystal ball. Thanks, Tom!