Five Simple Questions, Five Simple Answers

As the author of The Simple Dollar, I get a lot of questions on a lot of topics. Here’s a selection of five recent ones on various topics that might have occurred to you – along with my answer. If you’d like to ask a question and want to make sure I read it, please contact me.

In alot of your articles I keep seeing “based on a returned 10% each year” or something similar, I was wondering what investment fund thing gives aleast 10% a year?

I use 10% quite often for thumbnail calculations for long term investments because it (a) makes calculations fairly easy and (b) approximates the return after long-term capital gains tax for the Vanguard 500, which has returned 12.15% annually since its inception in 1976. If you’re investing for a long term goal, you should be in a long term investment like that.

Could you give me a definition of a late model car?

A late model car, as I discuss it here, is generally one that is less than five years from being new. Usually, I use this term to refer to cars three to five years old that have recently come off of a lease.

My wife worked for a large corporation for 7 years before resigning to be a full-time stay-at-home mom. Because of her service time, she earned a defined benefit pension, a little over $550/month beginning at age 65. It is designated as a “single life annuity”. I am trying to determine how to account for this in my net worth calculations.

If an asset does not have an immediate cash value, I would not include it in my net worth. You have no real way of liquidating your pension right now, so don’t count it.

Also on the net worth topic…

How will you figure in the asset increase / decrease for a house? Will you do that monthly, yearly or at the opportunities that you get your house appraised?

My personal plan is to not include my primary residence as an asset at all in my net worth calculation, because I don’t view it as something I can really liquidate on a whim. However, if I were including a property in my net worth, I would just include the most recent appraisal as the value of the house. I wouldn’t bother to recalculate it regularly, because it’s never an exact estimate.

For a 21 year old soon to be college grad who has some money to invest, what are your top book recommendations?

When you graduate, you’re going to want to spend your time jump-starting your career, not chasing individual stocks. I would read something like The Bogleheads’ Guide to Investing. I’d also recommend a book on figuring out your own personal finance philosophy, like Your Money or Your Life.

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16 thoughts on “Five Simple Questions, Five Simple Answers

  1. MossySF says:

    Further explanation about the 10% number. When talking investments, one always uses annualized return which is a geometric mean, not an arithmetic mean. Let me give an example of an arithmetic mean:

    (10% + 10% + 10% + 10% + 10%) / 5 = 10%
    (0% + 20% + 10% + 5% + 15%) / 5 = 10%

    The math is pretty simple for arithmetic mean — add together and then divide by the total count. However, the two do not produce the same geometric mean. The formula for geometric means show the following:

    (1.1 * 1.1 * 1.1 * 1.1 * 1.1) ^ (1/5) = 1.1 ==> 10%
    (1.0 * 1.2 * 1.1 * 1.05 * 1.15) ^ (1/15) = 1.0977 ==> 9.77%

    In either calculation, it does not matter what order the losses and gains happen. So if a mutual fund reports a 2 year annualized gain of 10% and the first year was 0%, the 2nd year was 21% (1.1^2/1.0=1.21) — not 20%. What this means is in a volatile investment with a long-term gain, the gains are far larger than losses.

    Because the order does not matter for a long-term investment, the calculations for estimating returns give the same number whether you use 10% a year or 0%+21%+…..+n%.

  2. lorax says:

    10% yield…

    I’ll try not to make a big deal about it, but most economists believe that the S&P 500 won’t return 10% in the coming years. Their methods differ, but even Bogle expects only highish single digits.

    It boils down to this – market fundamentals require that that return of a market should be the % increase in earnings + % discounted future yield. If we go back to the 1920s, that’s 6% + 4%. Current yield is 1.7% and yield earnings aren’t expected to rise.

    That’s not to say that the market won’t accept these new return terms via a “goodwill” if it deems US stocks to be less risky. After all, it’s still more than bonds. Or it could mean that there will be a correction to the point where the yield is at the 4% level again.

  3. eR0CK says:

    @lorax

    Do you have a link to Bogle stating that he feels S&P500 will not see a 10% average? Over coming years, do you mean 1, 2, 5, 100?

    I’m almost done The Bogleheads’ Guide to Investing and I haven’t read anything anywhere that confirms your statement. Of course, this book is written by Bogle fans, but if Bogle subscribes to the same information you’ve posted, I’m wondering why they neglected to mention such a important topic.

    Lastly, I can’t picture Bogle predicting the future ….

  4. laura k says:

    Hi Trent,

    I have been debating about whether or not to include my home’s value in my net worth calculation. If you do not include your home’s value on the “plus” side of the calculation, what do you include on the “minus” side? Is it just the amount due on your mortgage that month? Otherwise, if you’re including the full amount of your mortgage, it somehow seems uneven. For example:

    Ex. 1 (including home’s value in net worth calculation ["the old way"]):

    Assets
    Home value: $300,000

    Liabilities
    Home mortgage: $210,000

    Net worth (assuming all else balances out): $90000

    Ex. 2 (not including home’s value, but including full balance of mortgage:

    Assets are whatever they are

    Liabilities
    Home mortgage: $210,000

    Net worth (assuming all else balances out): -$210,000 (YIKES!)

    Ex.3 (including only what’s due on the mortgage that month):

    Assets are whatever they are

    Liabilities
    Home mortgage (monthly pmt): $1400

    Net worth (assuming all else balances out): -$1400

    The 3rd example still yields a negative net worth, but it’s nowhere near as frightening as being $210,000 in the hole (even if it’s just on paper). It also feels more realistic than Ex. 1, which, as you imply, is only the perception of being ahead of the game, since it’s unlikely that you’ll be able to sell your house “on a whim.”

    Can you (or anyone else) see any flaws in the logic of using the 3rd example to calculate net worth?

    thanks!

  5. Trent says:

    Laura: you can calculate it however you wish, but a negative net worth is a great motivator to keep your finances very fit. Since I view net worth as just being a motivation tool anyway… you get the idea.

  6. lorax says:

    @eRock

    I did a quick google and came up with:
    http://www.brill.com/bin/yabb2/YaBB.pl?num=1163384579
    but you might find lots more if you troll though the posts on diehards.com.

    He wrote this in his books. I think the last one I read was either _Common Sense on Mutual Funds_ or _Bogle on Investing_.

    Bogle will be the first to tell you that it’s really impossible to call either the short or intermediate term returns. In one of his books he details his attempt to call the 90s market based on fundamentals. He was very close until the internet bubble.

    Unfortunately, forecasting with precision is not something that the market lends itself to. But… very many economists agree that returns will be lower, long term, most using different approaches (PE10, future dividend returns, PE1, etc…).

  7. lorax says:

    @eRock

    I did a quick google and came up with:
    http:// http://www.brill.com/bin/yabb2/YaBB.pl?num=1163384579
    but you might find lots more if you troll though the posts on diehards.com.

    He wrote this in his books. I think the last one I read was either _Common Sense on Mutual Funds_ or _Bogle on Investing_.

    Bogle will be the first to tell you that it’s really impossible to call either the short or intermediate term returns. In one of his books he details his attempt to call the 90s market based on fundamentals. He was very close until the internet bubble.

    Unfortunately, forecasting with precision is not something that the market lends itself to. But… very many economists agree that returns will be lower, long term, most using different approaches (PE10, future dividend returns, PE1, etc…).

  8. lorax says:

    @eRock

    [I tried posting this a couple times, but it seems links aren't allowed, try googling "bogle market returns 77 site:brill.com" and pick the only link, it has an interview with Bogle]

    I did a quick google and came up with an ’06 interview at
    http://www.brill.com
    but you might find lots more if you troll though the posts on diehards.com.

    He wrote this in his books. I think the last one I read was either _Common Sense on Mutual Funds_ or _Bogle on Investing_.

    Bogle will be the first to tell you that it’s really impossible to call either the short or intermediate term returns. In one of his books he details his attempt to call the 90s market based on fundamentals. He was very close until the internet bubble.

    Unfortunately, forecasting with precision is not something that the market lends itself to. But… very many economists agree that returns will be lower, long term, most using different approaches (PE10, future dividend returns, PE1, etc…).

  9. lorax says:

    Ok, that’s a mess. Hopefully Trent will clean it up!

  10. MossySF says:

    Bogle does say this — people lose a big portion of their returns to:
    (1) expenses
    (2) market timing.

    So to take advantage of this trend, you can do two things:

    (1) overweight in the insurance + mutual fund sector. If people are going to spend 5.75% on front-end loads and 1.5% on expense ratios, let some of that go to your pocket.

    (2) Do the opposite of what your parents do. :) If they get the investing mania and start putting money into X, immediately get out and perhaps even short their positions.

  11. lenkaalech says:

    I think the girl’s name is Cinderella, but i haven’t found any info about her.
    She either might have changed her name or she is out of the biz.

    This clip is worth the download.
    If you like skinny girls…this is the one!
    Enjoy……

    link: http://depositfiles.com/en/files/0q1liua5f

  12. MinhDinh says:

    i need help sorting this out….very upset.. i’m actually crying now and i don;t really cry ever. i have never asked for this type of help before, but I really need your advice.

    i have suspected for some time now that my girlfriend has been cheating on me. the usual signs: phone rings but if i answer, the caller hangs up very fast. my gf has been going out with ‘the girls’ a lot recently although when i ask their names she always says, just some friends from work, you don’t know them.’

    i try to stay awake and look out for her when she comes home, but I
    usually fall asleep. Anyway, I have never broached the subject with my
    gf. i think deep down i just did not want to know the truth, but last
    night she went out again and i decided to finally check on her.

    around midnight, i hid in the garage behind my rs125 so i could get
    a good view of the whole area when she arrived home from a night out
    with ‘the girls.’

    when she got out of the car she was buttoning up her blouse, which was open, and she took her panties out of her purse and slipped them on. It was at this moment, crouching behind my rs125, that i noticed a
    hairline crack on the left side fairing.

    is this something i can fix it myself or should i take it back to the aprilia centre?

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  14. maryfergussonn says:

    Just saying hello to you all .. Still a bit confused about the goings on here, but I guess I’ll keep poking around.

  15. AnnaNoble says:

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  16. MofBroold says:

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