Archives For Dollar-Cost Averaging

For those of you not familiar with Pamela Yellen, she is the author of the Bank on Yourself strategy. She has written a couple of books espousing the insurance based strategy. I haven’t read them. What I have to say in this blog post has nothing to do with the message of her books.

I can understand an insurance person not liking the stock market. I get it. When you sell products that are supposed to “reduce risk” you’re not going to be a fan of something like the stock market.

What I don’t like and can’t respect is a person who willingly misleads others by not telling the whole truth.

How does Ms. Yellen mislead her followers?

Take a look at the following snippet that was recently published on her blog:

Okay… so over the last nearly 16 years, since January 1, 2000, the S&P 500 (which represents the broad market) has had only a 2.15% average annual gain.

Did you guess that it was more than 2.15%? Most people do.

And coincidentally, that 2.15% per year return was cancelled out by the 2.19% average annual rate of inflation during that same time period! Oops!

So, was that return worth the risk you took? Was it worth your sleepless nights?

It Gets Worse, Because You Didn’t Actually Get that 2.15% Average Return – Here’s Why…

For starters, in order to participate in the returns of the S&P 500 (or any other index), you have to buy a financial product, like an S&P 500 Index mutual fund or an Exchange Traded Fund.

And those financial products have fees, typically totaling at least 1% per year.

So when you subtract that from the 2.15% annual return of the index, well… now you’re down to maybe 1.15%.

Which means, when you factor in inflation, you’ve actually been going backwards for the past 16 years. All that risk for so little reward.

Now take a look at the chart she included in her post:

Yellen's Chart

Look closely. What did she conveniently leave out?

DIVIDENDS!

I have called her out on this before (NOTE: I have since been banned from leaving comments. Only people who agree with her are allowed to post comments on her blog.). She claims that talking about dividends would confuse the matter. Interesting. Dividends will confuse people, but using the price return for an index and then subtracting off another ONE PERCENT for management fees and then reducing it even more for inflation isn’t confusing?

Because I’m a nice guy, I will help Ms. Yellen out with the math. To be fair, I used the Vanguard S&P 500 Index Mutual Fund (VFINX) since it is an actual investment vehicle and not just an index. Its adjusted close on December 31, 1999 was $102. Its adjusted closing price on December 16, 2015 was $192.11. There were 15.96 years between the two dates, giving us an average annual rate of return of 4.05%. The math looks like this:

[(192.11 ÷ 102)1/15.96] – 1

[1.883431.062657] – 1

1.040465 – 1

.040465 or 4.05%

That’s roughly 3.5 TIMES the return Ms. Yellen posted on her blog!

I’ll be the first to admit that stock market returns have not been great during the 2000s, but they haven’t been nearly as bad as Ms. Yellen makes them out to be.

Not only that, most people have to dollar-cost-average into an investment. For kicks, I ran the numbers to see what the personal rate of return would be for someone who invested $100 each month into VFINX since December 31, 1999. Using the XIRR function in Excel, I found the personal rate of return to be 7.95%. This is due to the fact that the investments are made a little at a time over a long time horizon.

For someone who holds herself out as an “expert,” she should know better.

For your entertainment, here is my first post regarding Ms. Yellen’s tactics from 2014.

UPDATE: I just ran the numbers to reflect the last two down days (the DJIA has lost over 600 points on Thursday and Friday (12/17/2015 – 12/18/2015)). The personal rate of return for 12/31/1999 through 12/18/2015 is 7.44%.

At the time of this writing, Vanguard’s S&P 500 Index Fund (VFINX) is down 14.04% year-to-date (not including dividends). Where would you be had you dollar-cost averaged into VFINX during the year? To arrive at that answer I assumed a few things:

1. Invested $500 on the 1st and 15th of each month.

2. If the 1st and the 15th fell on a weekend or holiday, I used the price for the trading day preceding the 1st or the 15th.

3. I assumed this was a 401(k) account.

So, here’s where you would stand right now had you invested $500 into VFINX on the 1st and 15th of every month during 2008:

So, you would have invested $7000 during the year and it’s worth $6,509. You’re down 7.01%, right? Not exactly.

Why?

Because you weren’t fully invested the entire year. In order to figure out your personal rate of return, you need to add in the purchase dates. The easiest way to do this is with Excel’s XIRR function. I ran the function myself. Here are the results:

So, according to those numbers, you’re personal rate of return is -22.68%, which is an annualized number. Sounds scary but keep in mind that it wouldn’t take much of a rise in the price of VFINX for that number to become positive. I was playing around with the numbers and figured out that if VFINX went up to $125, you would actually have a positive personal ROR even though the fund would still be down over 7.51% for year.

So, even though it stinks to watch your periodic investments drop in value, in the long run, it’s a good thing if you’re dollar-cost averaging.