Why the Dow Jones is a flawed index

*yawn* Oh hello there! Welcome back. Did you miss me?

Sorry for the extensive delay (348 days), but after five years of vociferous posting, I needed to take some time off. But now I am back! And I am here to talk about everyone’s favorite topic – the stock market.

The stock market is of course the huge soup of publicly traded securities that investors (and algorithms) buy and sell everyday. And to determine how the market is doing, we rely on indexes. The three most popular are the Dow Jones Industrial Average, the S&P 500, and the NASDAQ. The Dow tends to be the default index we use in everyday conversation. It is the oldest and the most famous, and it crosses over big, round numbers more often than the other indexes. Last week, the Dow passed 25,000*, which elicited a tweet from our Dear Leader:

Investing legend Art Cashin even gets a new hat every time the Dow crosses 1,000.


*By the way, in 2014, I made some predictions of things that will happen in my life. One of them is that the Dow will reach 100,000, which is absolutely going to happen (a conservative 3% per year for 50 years will get us there). And one of my predictions has already come true – the Cubs won the World Series!

Hey, there is reason to be excited. The Dow was as low as 6,443 in March of 2009, which means the index has roared almost 300% in the last nine years (not including dividends). This is good news for the 52% of Americans who own stocks.

But there are two flaws with the Dow Jones.

NUMBER ONE, the Index does not capture the performance of the broad market. It only captures the performance of 30 stocks which are arbitrarily selected, can change year-to-year, and exclude some of the largest companies like Google, Amazon, and Facebook.

NUMBER TWO, the Index is price-weighted. The problem here is that share price has nothing to do with how big a company is. So the companies with the highest share price (regardless of size) have more influence on the index. A company like Boeing ($318/share) has seven times the influence as Coca Cola ($46/share) and almost twice as much as Apple ($174/share). This isn’t right.

In the world of most investment professionals, the index du jour is the S&P 500. It tracks a broader group of stocks (505 to be exact), is weighted by market cap (so the largest companies have more influence), and measures most of the stock market’s value.

OK, we good? You realize the Dow has some serious flaws? Good. Thank you.

Now for some caveats.

NUMBER ONE, the Dow Jones has a rich history. It is the oldest index (started in the 1890s), it’s quoted everywhere, and it’s familiar. ‘The market’ and ‘The Dow’ have become synonymous with each other. It’s what we use in conversation. I wouldn’t want it to go away.

NUMBER TWO, the Dow Jones closely tracks to the S&P 500 over time, so perhaps I am wasting your time with pedantry where none is necessary (thanks Josh):


To me, the Dow is like the pitcher win in baseball. Historically, the win was the common benchmark for things like Cy Young and Hall of Fame voting.

But over time, other stats emerged (WHIP, ERA+, FIP, WAR), and now we know that there are better ways to measure performance. But, like the Dow, I don’t want the win to go away. Even if it means nothing, there is something comforting about seeing a pitcher get to 15 or 20 wins.

And, admittedly, there is some comfort in seeing the Dow cross 25,000.


In which jfleishman gives a year-end address to his nonexistent investment clients

Good evening, thank you, thank you, please, hold your applause. We here at Fleishman Wealth Management are delighted to report that 2016 was another excellent year for our clients, particularly because we continued with our decades-long philosophy of doing nothing and throwing up our arms and saying ‘lol, idk’ to explain every move in the stock market.

You may remember January, when the S&P 500 lost 10.5% in the first 28 trading days of the year. It was the worst start to a year for US stocks ever. Ever! And many of our competitors saw that as a sign that things were bad and it was time to pull out of the markets. Our friends at RBS said to sell everything. Time to liquidate your 401(k), folks!

And there were lots of good reasons to believe them: falling oil, volatility in China, shrinking world trade, rising debt, weak corporate loans, and deflation. Heck, this was before Brexit or President Trump entered the scene.

But at Fleishman Wealth Management, we did not panic. We did not sell a single share of stock. We actually bought more!

Here is what happened next.


Over at The Reformed Broker, Josh Brown explains:

It’s important to note that this happened in the absence of quantitative easing by the Fed and with the pace of US stock buybacks down substantially from the prior year. This also happened in the context of an “earnings recession” and with all of the uncertainty of the most rancorous election of our lifetime, slowing Chinese economic data, Brexit, a spike in European nationalism and all of the other horrible sh*t you could toss into the cauldron.

The stock market will not go up every year. And we will have future downturns and recessions and plenty of other bad things that we can’t see coming. But who’s to say when that will happen and how that will affect the market. A lot of bad stuff happened this year, frikkin’ Donald Trump is President, and the market is up 20% from its January lows. Um, ok.

We don’t try to explain the unexplainable at Fleishman Wealth Management. Many of you are frustrated by this. We just diligently save and invest your money, in a broad range of stocks, at every downturn, and at every upturn. And, I would say we’ve done quite well. You wanted to pull out in 2000. You wanted to pull out in 2008. And believe me, we understand that it’s not fun to watch your accounts get cut in half. This game is not easy. But ultimately, you’ve stuck with us. And I don’t want to brag, but you’re all better for it.

Patience in this game is a good thing. Warren Buffett once said, the stock market is a device for transferring money from the impatient to the patient. We don’t accept impatient clients in our firm. We don’t accept day-traders or speculators or people who yell loudly. We’re quiet and boring, and we like it that way.

Here’s the thing, folks. You have to invest. You have to do something with your cash to beat the rate of inflation over time. Jack Bogle once said that the only way to guarantee you will have nothing at retirement is to invest nothing along the way.

And yes, investing is hard. Loss aversion is a powerful force. There will always be risks in the market. But the alternative for stepping out into the unknown is the known of never building your wealth.

You have to take your chances. Thanks for taking them with us.

How to save for retirement

The other day, I received this message:


I’m a firm believer that educating yourself on the basics of investing, personal finance, and retirement saving is one of the most important things you can do in your twenties. A working knowledge of this stuff can have a big pay-off in the form of your standard of living, your financial freedom, and your general sanity. Unfortunately, it’s not taught in school. It’s on us to learn it and apply it.

OK – to start, there are few main investment vehicles you can use to save for retirement: a 401(k), a Roth 401(k), a normal IRA, and a Roth IRA. All of these are useful because they grow your investments tax-free, meaning you don’t pay taxes on any earnings or dividends.

You may know all of this already, but in case you don’t:

A 401(k) is a retirement savings plan that is sponsored by an employer. It lets you save and invest a piece of your paycheck before taxes are taken out. A lot of times, your employer will match a certain portion of your 401(k) contributions (3 or 4%, sometimes more). You should, at a minimum, invest the same as your employer match. This is what we in the business call ‘free money.’

Once you sign up for your company’s 401(k) plan, you’ll have a list of stocks or mutual funds to pick from. Each company’s plan is different – some have 10 choices, some have 100. The funds you choose are entirely up to you (you can put everything in one fund, or in five different funds, whatever you want), but there are certain things to be wary of (namely, fees) that we’ll tackle later.

The money in a 401(k) sits there for a very long time, and it will grow with each paycheck and with each rise in the market. Sometimes it will fall, like in 2008 when the stock market halved. But there’s no need to worry about the daily, or even yearly, moves in the market, because you can’t touch the money* in your 401(k) until you’re 59 1/2 years old. And, thankfully, 40-year market returns are pretty great (the market has risen 2,100% since 1976).

*Well, this isn’t entirely true. You are allowed to withdraw funds from your 401(k) early (usually in an emergency), but you have to pay a 10% penalty, in addition to taxes.

A 401(k) offers lots of great benefits (employer match, tax-free growth), but there’s a limit of how much you can put into it each year. For 2016, that’s $18,000. If, for some reason, you accidentally contribute more than $18,000, you have until tax time (April) to withdraw the excess and set everything straight (or else you pay a penalty).

Some employers also offer a Roth 401(k). It’s very similar a normal 401(k) – a small portion of your paycheck gets set aside for retirement, but it’s taken out post-tax instead of pre-tax. So you pay tax on it now instead of later.

A traditional IRA is an individual retirement account that you have outside of work. It’s similar to a 401(k) in that you contribute your money on a pre-tax basis, so you don’t pay tax on it until you withdraw funds down the road. Most of the major banks and financial institutions offer some sort of IRA.

Roth IRA is like an IRA, but your contributions are post-tax instead of pre-tax. In other words, you can contribute your ‘take-home pay’ to a Roth IRA, and since you’ve already paid tax on it, you can withdraw funds tax-free. The two things to be aware of with a Roth IRA – the maximum you can contribute is $5,500 per year, and you can’t contribute if you make more than $132,000.

In summary:

401(k) Roth 401(k) IRA Roth IRA
Eligiblity if your employer offers it if your employer offers it anyone if you make less than $132,000
Max annual contribution $18,000  $18,000 $5,500 $5,500
Are deposits taxed? no – your deposits come directly from your paycheck, pre-tax yes – your deposits come directly from your paycheck, post-tax yes, but they’re tax-deductible if you don’t have a 401(k) yes
Are withdrawals taxed? yes no yes no
When can you withdraw? age 59.5, required by 70.5 age 59.5, required by 70.5 age 59.5 age 59.5, required by 70.5
Early withdrawal? minimum 10% penalty  ok, but you have to pay taxes on the earnings ok for high medical bills, $10K towards a first home, higher education, disability, or death; otherwise, 10% penalty ok for high medical bills, $10K towards a first home, higher education, disability, or death; otherwise, 10% penalty

Personally, I have a 401(k) through my job and a Roth IRA (with Fidelity) on the side.

Here are some general best practices for saving for retirement:

Start now. In the world of saving and investing, the most precious resource you have is not smarts or analysis or research. It’s time. The power of compound interest over a thirty or forty year period is amazing.

This is a real quote from Albert frikkin’ Einstein:

Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.

Here’s the example I always use at parties. If I…

Save $10,000 a year from age 22 to 30, and then I stop and never save another dime for retirement.

And you…

Save $10,000 a year from age 31 to 60…

Guess who ends up with more money at age 60? Me! Even though I saved $220,000 less than you did.

No one ever seems to believe me, so then I load up Microsoft Excel, input the numbers, show them the data, grab ’em by the shoulders and shake ’em, and stare intimately into their eyes until they finally start to understand.

This is something that isn’t taught, and unfortunately a lot of people don’t fully appreciate the power of time until it’s far too late. So what I would say is: start now, contribute what you can to your retirement accounts (start at 5%, and go from there), and your future self will be quite happy. He or she exists, and you will soon become that person. Unless something terrible happens. Don’t die.

Do not invest in individual stocks. This is just my own personal philosophy, but I don’t think you should invest in individual stocks in your retirement accounts. Why? Because you’re not touching that money for forty years, bub, and a lot of companies aren’t going to be around in forty years. Instead, I would recommend a mutual fund that closely tracks the broad US stock market. A mutual fund, by the way, is just a collection of stocks (and/or bonds), so you hedge yourself against the failure of a single company. In other words, don’t put all of your eggs in one basket.

That’s not to say that you shouldn’t invest in individual stocks. By all means, go crazy! Just don’t do it in your retirement accounts, please. Also, stock-picking is a tricky thing. Most stock-pickers don’t beat the market. The one exception is my friend Eddy Elfenbein, who routinely beats the market, and spoke with me about it two years ago.

Watch out for fees. OK, great, you realize that investing is important and you’re committed to setting aside $10,000 every year until you retire in forty years. On average, let’s say your investments increase by 8% annually over the next forty years, which is actually lower than the long-term average. You pay, on average, a 0.25% fee on your investments. In forty years, you’ll have $2,613,971.03.

Now let’s say you invest that same $10,000, over the same forty year period, in the same kind of funds, so on average you’re still getting 8% per year. But the funds you chose charge 1.25%, not 0.25%. In forty years, you’ll have $1,998,500.80.

In other words, a 1% higher fee will eat 25% of your total investment value.

It doesn’t sound right, but I’ve done the math and the people who are selling these things hope you haven’t. Fees are absolutely debilitating over the life of your investments, which is why the majority of your investments should be in low-cost funds, ideally 0.50% or less.* Companies justify their higher fees by saying they produce higher returns, but that is categorically untrue. But don’t take my word for it. Read this or this or this or this or this or this or this.

*But the fee shouldn’t be 0%. You SHOULD be paying a small fee for all of the things a mutual fund can do for you – re-balancing, tracking the market, hedging against the failures of an individual stock, creating tax advantages, and (hopefully) giving you a nice safety net when all is said and done.

Think of a mutual fund as a product.

The more expensive one’s, generally called ‘active funds’, will have lots of smart people looking at lots of data to try to maximize the performance of the fund. The idea is that you, as the consumer, will be rewarded, in the form of a superior return, for paying a higher fee. You pay more to get more.

The less expensive funds, called ‘passive funds’, will contain a bunch of stocks that mimic the direction of the Dow Jones or S&P 500 Index or perhaps another sector. Passive funds are not actively managed, and they are built for the long haul. It’s a ‘set it and forget it’ strategy. If the market does well, then great, so do you. If the market doesn’t do well, then neither do you.

Again, the problem with the first strategy is that it’s really hard to beat the market. In the last year, 90% of US equity funds failed to do so. Every now and then, a fund like Peter Lynch’s Magellan Fund will come around, which averaged a 29.2% annual return from 1977-1990 and had the best 20-year return of any mutual fund ever. But these are rare.

The real danger with fees is that they aren’t very transparent, and you’re not actively paying the fee when you withdraw your money. Fees are baked into a fund’s NAV (net average value), or the share price of the fund. So you never see exactly how much you’re paying in fees. All funds are, of course, required to disclose their fees, but they’re not required to tell you. Thankfully, things like Google and Yahoo Finance exist, so they’re pretty easy to look up.

OK, so I understand that compound interest is amazing and fees are awful, plus all of the other stuff you said. So what should I specifically invest in, smartypants? 

An example of a low-cost mutual fund that tracks the S&P 500 is the Vanguard Total Return Index (VFIAX), which recently celebrated its 40th anniversary.

The Vanguard Total Return Index is pretty boring. It tracks the broad US stock market. It has an expense ratio of 0.05%. It holds some winners and some losers – it’s not loaded with tech start-ups in Silicon Valley, or emerging markets like China or India, or whatever the hottest trend is of the day. Nope, it just trudges along, facing strong headwinds here and there like recessions and wars and inflation and panics. But the fund rewards patience. It has a cumulative total return of 6,091%, or 10.86% annually.

Not every 401(k) plan will offer Vanguard funds, but thankfully it’s far from the only low-cost mutual fund out there. There are hundreds of them now. Fidelity offers one (FSTVX) with an expense ratio of 0.045%.

Vanguard, by the way, has become the single most influential force in the asset management industry. It’s been estimated that the firm has saved investors approximately $1 trillion in unnecessary fees over the years.

Got it? Good…wait…what…oh God what else do you want?

This all sounds great, but I don’t really want my money to track the stock market, because market volatility gives me severe diarrhea and I’m worried Trump will become President and everything will go to hell.

That’s a valid concern. Some people don’t want to take on the added risk of investing their hard-earned money in the stock market. Market crashes happen every few years, and they’ll happen again.* It’s completely understandable if you’re scared of the stock market, though I’ll mention that historically, the market provides the best returns of any investment vehicle – more than real estate, more than bonds, more than CD’s, more than beanie babies, more than my baseball card collection, all of it.

*Not just because of macroeconomic events or terrorism, but because of anything. Just recently, the market dipped 20% because of ebola (remember that?). Who knows what the next 40 years will bring! I’m guessing: climate change, solar flares, super virus, alien invasion, and robots who don’t listen to directions.

If you want to avoid diarrhea, I would recommend allocating part of your retirement funds (say, 40%) to bonds or other fixed income products. You’ll take on less risk (yay!), but you’ll probably see lower returns over a long period of time (boo!). That’s how the game works.

And then as you get closer to retirement, you should start shifting more and more of your money into fixed income products. When you’re 65, a guaranteed rate of return (even if it’s lower) will be more important than the whimsies of the stock market.


Start investing as early as you can.

Take advantage of your company’s 401(k) plan.

Invest in simple, low-cost mutual funds that track the broad US stock market. Or invest part of your portfolio in bonds, if you’re more risk-averse.

Watch out for fees.

Continue to make contributions, regularly, for the next four decades or so.

Enjoy your retirement!

Also, try not to lose your job.

All of this advice is very specific to someone my age – mid-twenties, out of school, working full-time. If you’re older, it’s a different story. If you’re in debt, it’s a different story. If you’re saving for your kids’ college, it’s a different story.

If you have any specific questions, or would like some further elaboration, feel free to email me or comment below.

Tax policies of Clinton, Sanders, Trump, and Cruz

I recently watched the vlogbrothers videos that explained the tax policies of Clinton/Sanders and Trump/Cruz. They were really well made and informative and relatable and I wish the regular media would do stuff like this.

Tax policy is, of course, not everyone’s cup of tea, but presented the right way it can be somewhat interesting. So let’s spend today looking at the tax policies of the four remaining Presidential candidates.*

*I meant to post this before Ted Cruz dropped out.

OK, so to start: in 2015, the United States government spent $3.8 trillion dollars, divided up like so:


Now that you have that baseline, let’s look at everyone’s tax policies:

Ted Cruz


Cruz’s tax policy dramatically simplifies the American tax code, to the point where he would abolish the IRS.

Currently, we have seven tax brackets. If you filed as a single taxpayer in 2015, you paid:

10% on your first $9,225 earned
15% from $9,226 to $37,450
25% from $37,451 to $90,750
28% from $90,751 to $189,300
33% from $189,301 to $411,500
35% from $411,501 to $413,200
39.6% for $413,201 to ∞

This is, of course, minus any deductions – interest on a mortgage, charity donations, student loan interest, child care costs, or just the standard federal deduction (which anyone can take – in 2015, it was $6,300).

Cruz wants to a flat tax of 10%, with a $10,000 standard deduction. Let’s look at how that would effect millionaires:

Current Cruz
Income $1,000,000 $1,000,000
Standard Deduction $6,300 $10,000
Taxes Owed $349,874 $99,000
Tax Rate 35.0% 9.9%

They’d pay a lot less in taxes. How about someone who makes $250,000:

Current Cruz
Income $250,000 $250,000
Standard Deduction $6,300 $10,000
Taxes Owed $64,027 $24,000
Tax Rate 25.6% 9.6%

They, too, would pay a lot less in taxes. What about someone making the median US average of $52,000:

Current Cruz
Income $52,000 $52,000
Standard Deduction $6,300 $10,000
Taxes Owed $7,894 $4,200
Tax Rate 15.2% 8.1%

So everyone would pay less in taxes, but the wealthiest Americans would by far receive the biggest cuts.

Cruz would also eliminate many tax deductions except for mortgage interest and charitable donations. He would also eliminate all federal gift and estate taxes, and repeal all corporate and payroll taxes in favor of a 16% VAT (value added tax). This would be a tax on business revenues, minus their capital investments and the money they pay to other companies.

The problem with Cruz’s tax plan is that it would dramatically reduce the amount of federal revenue, by approximately $8.6 trillion over the next ten years. Cruz says that by eliminating the IRS and some other government programs, they can save maybe $500 billion over the next decade, but that’s still $8.1 trillion short. Even if you cease all military spending*, you’re still be $2 trillion short.

*Cruz, of course, wants to increase military spending.

Some economists argue that the shortfall would be partially offset by increased economic growth, but even the most optimistic models show a dramatic increase in the federal deficit, unless we also cut Medicare or Social Security. So, yeah, Cruz’s tax policy would be awful for a lot of people. And I’m not saying that because I’m a liberal hippy from New York. I’m saying that because MATH.

Donald Trump


Trump wants to increase the standard deduction by more than Cruz – $25,000 for single filers and $50,000 for married couples filing jointly. He would then collapse the seven tax brackets into four, with the top rate being 25% on income over $432,000 per year. Trump would also eliminate federal gift and estate taxes and most deductions. But he would cut corporate tax rates instead of replacing them with a VAT.

Trump’s tax plan actually costs the federal government more than Cruz’s plan, which I didn’t think was possible. It’ll cost the government between $10 and $12 trillion over the next decade. Trump argues that his tax plan will be revenue neutral, but even the right-leaning Center for Federal Tax Policy wrote an op ed that was titled:

Donald Trump’s Tax Plan Will Not Be Revenue-Neutral Under Any Circumstances


Trump could dissolve the military, and he’d still need to find $6 trillion to cut in order to make his policy revenue neutral.

I’d like to sit down with Trump (or Cruz) for an hour and go through some of the math in Microsoft Excel. I’d run some calculations and conclude by saying:  Look at the math, ya dingus. At that point, I imagine they would drop out of the race in shame.

Hillary Clinton


Clinton’s tax plan is simple: KEEP EVERYTHING THE SAME.

There is one slight exception: she wants to add a higher tax rate (43.6%) for any individual that makes over $5 million.

Bernie Sanders


Under Sanders’s tax plan, everyone pays an additional 2.2% tax, which goes towards paying for a single-payer healthcare system. He also adds some additional brackets:

12.2% on your first $18,000 earned
17.2% from $18,001 to $75,000
27.2% from $75,001 to $150,000
30.2% from $150,001 to $230,000
35.2% from $230,001 to $250,000
39.2% from $250,001 to $500,000
45.2% from $500,001 to $2,000,000
50.2% from $2,000,001 to $10,000,000
54.2% from $10,000,001 to ∞

Sanders’s tax plan is considerably higher. Also – one thing he does that neither Cruz, Trump, nor Clinton do is increase the payroll tax by 6.2% to further fund his single payer healthcare system and two years of free education (the payroll tax normally includes stuff like Social Security (12.6%, 6.2% of which is paid by you and the other half paid by your employer) and Medicare (2.9% below $250,000, 3.8% above), which is automatically deducted from each paycheck).

Additionally – Sanders would re-introduce the Social Security tax at $250,000 (right now, you do not pay Social Security tax on any income over $118,000). So under his plan, you do not have to pay Social Security tax between $118,000 and $250,000, but you do have to start paying it again after $250,000.

The taxes are ridiculous – if you make more than $5 million, you’ll be taxed at 70.4%* (with payroll taxes), plus all of the required state and local taxes. Even if you make $50,000, you’ll be taxed at 32.5%.**

*54.2% + 6.2% Social Security tax + 6.2% single payer healthcare tax + 3.8% Medicare tax

**17.2% + 6.2% Social Security tax + 6.2% single payer healthcare tax + 2.9% Medicare tax

Sanders would also add his 2.2% tax increase to capital gains, and he would tax all capital gains above $250,000 as normal income.

Of course, Sanders’s increased taxes are partially offset by lower healthcare premiums. So the idea is that while your taxes go up, the average person would pay less money per year in healthcare costs.


In summary, Cruz and Trump want to significantly lower taxes, which will make your paycheck bigger but will leave the federal government vastly under-funded. Clinton wants to continue the same tax policies as Obama. Sanders wants to add new taxes, especially for those with high incomes, that will pay for a single payer healthcare system and free education. Got it? Good. Tax policy is exciting.

Stock market facts

When it comes to the stock market, I am an unabashed optimist. This is true about most things, I guess. I think back to what Eddy Elfenbein said a few months ago:

I am always an optimist. I think we are going to have a very robust stock market. I think there are going to be tons of innovative companies that will bring us lots of new toys to play with. I think people will live longer and they will be healthier, and I think it will be a more peaceful world. I think the market is a great place to be and will continue to be a great place to be. The free exchange on the market is one of the great inventions in human history.

A lot of people view investing in the stock market as if you are investing in a thing, or some non-living corporate entity. But what you’re actually investing in is people and ingenuity and progress and hope.* When you invest in something, you are giving your money to people in the hopes that they will make something better. And humans have gotten very good at making things better.

*A company is sorta like a car. Like, I look at a car and I don’t normally think of a person behind the wheel. I just see some big scary machine that is whizzing towards me. The same goes for Apple or Google or Facebook. There are real people behind the machine.

Anyway, here are some market facts, with all bias removed. I’ve gathered these from a wide array of financial sites over the last few days.

– In the last 89 years, stocks closed at least 20% lower six times.

– In the last 89 years, stocks closed at least 20% higher thirty-five times.

– Since March 2009, the S&P 500 has more than tripled. It has gone from 666 to 2090, about a 21% annual gain over six years.

– Apple IPO’d in 1980 at $22. If it had never split, today’s price would be $6,776. This week, it became the first company to surpass $700 billion in market cap.

– More jobs were created in 2014 than during any year since 1999.

– US household net worth hit $81.5 trillion. This includes all stocks, bonds, properties and business values, minus any debts or liabilities. This is a new all-time record.

– US energy consumers have received a cumulative $14 billion tax cut (and counting) as a result of the oil price decline since June.

– We won’t know until the CPI report comes out, but the S&P 500 may have reached an all-time inflation adjusted high today.

The stock market is a crazy, confusing, unsettling world for many people, and that’s especially true if you track its day-to-day movements. And, yes, it can drop at any time. It doesn’t take much to send investors into a panic. But on the whole, it is a remarkably efficient vehicle for returning long-term wealth.

Thoughts on personal finance (with spreadsheets!)

I am going to attempt to write about something different here on the blog.

I was having a conversation last week with my parents, and we were talking about personal finance, and I’m no expert on the subject, but I was a finance major, and I have picked up a few things over the years.

Anyway, during the conversation I said two remarks that they didn’t seem to believe, or certainly didn’t sound right without any support.

The money you save from age 22 through 30 will be worth the same as the money you save from age 30 through 60.

Holding off social security benefits until you are 67 will give you an extra $100,000.

Well, I have an obligation to back up these statements.

Let’s tackle the retirement issue first. The reason why saving in your twenties is so important is because of compound interest, a magical quirk of math that is the foundation of passive investing. In the finance world, we call this the time value of money.

Let’s say you save $10,000 a year for retirement for 40 years. Let’s assume you can grow your money at 7% per year, which is about what you can expect for your returns if you’re in the stock market.*

*Over the last 40 years, the S&P 500 has actually gained 8.3% annually, plus dividends. On July 9, 1974, the S&P stood at 81.48. It currently stands at 1972.83. For the purposes of this exercise, we’ll keep the rate at a conservative 7%.

Returns are certainly volatile year-to-year, but time is on your side. The market has been remarkably efficient.

OK, so, after 40 years you’ll have put $400,000 towards retirement. Well done. For your efforts, you will end up with a cool $2,136,096. Here is a model I built that shows the underlying calculations.

If you had saved for 30 years instead of 40, you end up with $1,010,730, which is still a nice number, but it’s less than half of the $2.1 million.

So, yeah, the money you save in your twenties is worth about the same as the money you save for the rest of your life. Every dollar you save now is worth $7.60 in 30 years, but jumps to $15 in 40 years.

This assumes that you’re investing in a wide range of mutual funds and aren’t putting everything you’ve got into, I don’t know, a tech company in the late 90s.

Of course, this calculation is leaving out a major factor: inflation. Lately, inflation has been hovering around 2%. Historically, it’s been a little higher, reaching as high as 14% in the late 70s and early 80s. If we assume 2% annual inflation for the next 40 years, then your REAL annual return is about 5%.

How does that affect your retirement savings in real dollars? After 40 years, you’ll have $1,268,398 in today’s dollars, which is still about twice as much as you would have had after 30 years. Here is a model I built that factors for inflation.

Now let’s tackle the Social Security issue. Right now, eligible retirees are able to collect Social Security at age 62. However, you have the option of deferring payments until you are 67, which results in a higher monthly payout.

The numbers vary person to person, but I did some research and ballparked the monthly payouts like this:

Retire at age 62: $1,300/month
Retire at age 67: $1,860/month

According to different sources I looked at, Social Security benefits are 30% lower at 62 than at 67, so these numbers are consistent.

Most will opt for the earlier payouts. And, that’s totally understandable, given the financial situation of many retirees. An extra five years of income goes a long way.

But, if you can get through those five years, you’ll be thankful. You break even when you’re 78. If you think you can make it to 80, it is worth holding off.

When you’re 85, you’ll have an extra $50,000.

When you’re 90, you’ll have an extra $83,000.

If you can make it to 100 – and, hey, don’t discount the possibility – you will have an extra $150,000. See here for the calculations.

I wish there was more of an emphasis on personal finance in high school and college. There was hardly any mention of it. So when you graduate college, you’re pretty much on your own in this strange world of taxes and 401k’s and IRA’s and the stock market. Thankfully there are some wonderful websites out there that walk you through the basics of handling a budget, saving for retirement, and investing wisely. I like Betterment.

Unfortunately, none of this is taught. It falls on us to take the initiative.