The last 10 years of stock market returns have been pretty remarkable. If you invested $100,000 in the S&P 500 in the year 2000 and held it though the dot-com crash and financial crisis, you would be closing in on $300,000 today. However, if you retired in 2000 with a portfolio invested in the S&P 500 and used a 4% withdrawal rate (increasing each year by 3% for inflation), your nest egg would less than $50,000 and on a path to zero!

This stark difference between accumulation and withdrawal modes is illustrated by the chart above, taken from the Blackrock Blog post How to avoid “dollar cost ravaging” in retirement. “Dollar-cost ravaging” is also known as “sequence of return risk”, as explained in the this quote:

Investors have probably heard the term “dollar-cost-averaging,” where you make regularly timed investments to smooth out the risk of “buying high.” Retirees tend to do the opposite. Instead of putting money into their portfolio, they take it out with a regular cadence in the form of income. “Dollar-cost-ravaging” occurs when the market loses value while you’re taking withdrawals, especially in the early years of retirement. Because money is coming out rather than going in, it’s harder for the retiree to recover their losses when markets rebound. We even saw this during one of the most successful bull markets in our history over the past decade. The sequence of returns matters, and the biggest challenge is a bear market early in your retirement.

Unfortunately, there is no easy solution to this problem. This is what the article offers: “Striking the right balance to limit your losses in a declining market is just as important as capturing growth when the market is strong.” In other words, don’t hold too much in stocks, but also not too little. You can more easily weather a recession when you are still working and saving then when you are spending it down. I think more important advice is that you should be ready to withdraw less money out of your portfolio if the market tanks early on in your retirement withdrawal phase. Don’t follow a rigid withdrawal rule from some academic study into oblivion!

Now that you’re done reading articles about what happened in 2019, how about stepping back and taking in the longer view? Most successful savers invest money each year over a long period of time, these days often into a target-date fund (TDF). It may not get you doing silly things on a super-yacht, but this slow-and-steady behavior is a perfectly legitimate way to build wealth. Not everyone gets rich with IPOs or Bitcoin.

Investment benchmark. I chose the Vanguard Target Retirement 2045 Fund as this all-in-one fund is low-cost, highly diversified, and available both inside many employer retirement plans and anyone with an IRA. During the early accumulation phase, this fund holds 90% stocks (both US and international) and 10% bonds (investment-grade domestic and international). I think it’s a solid default choice in a world of mediocre, overpriced options.

Investment amount. For the last decade, the maximum allowable annual contribution to a Traditional or Roth IRA has been roughly $5,000 per person. The maximum allowable annual contribution for a 401k, 403b, or TSP plan has been over $10,000 per person. If you have a household income of $67,000, then $10,000 is right at the 15% savings rate mark. Therefore, I’m going to use $10,000 as a benchmark amount. This round number also makes it easy to multiply the results as needed to match your own situation.

A decade of real-world savings. What would have happened if you put $10,000 a year into the Vanguard Target Retirement 2045 Fund, every year, for the past 10 years? You’d have put in $100,000 over time, but in more manageable increments. With the interactive tools at Morningstar and a Google spreadsheet, we get this:

Investing $10,000 every year for the last decade would have resulted in a total balance of $174,000. That breaks down to $100k in contributions + $74k investment growth.

Are you a dual-income household that can put away more? If you were a couple that both maxed out their 401k and IRAs at roughly $20k each or $40k total per year, you would have a total balance of $700,000! That breaks down to $400k in contributions + $300k investment growth.

Bonus: 15 years of real-world savings. What would have happened if you put $10,000 a year into the Vanguard Target Retirement 2045 Fund, every year, for the past 15 years instead? (Now $150,000 total.) This is a self-centered inclusion as it has now been 20 years since I graduated college and 15 years since starting this blog. Here are the extended return numbers:

Investing $10,000 every year for the last decade and a half would have resulted in a total balance of $307,000. That breaks down to $150k in contributions + $157k investment growth. Your gains are now officially more than what you initially invested!

Are you a dual-income household that can put away more? If you were a couple that both maxed out their 401k and IRAs at roughly $20k each or $40k total per year, you would have a total balance of over $1,200,000! That breaks down to $600k in contributions + $620k investment growth.

Timing still matters, but not as much as you might think due to the dollar-cost averaging and longer time horizon. Yes, the last decade has been a great run for US stock markets. But Vanguard Target funds also own a lot of international stocks, which haven’t been nearly as hot and have maintained lower valuations. More importantly, you can’t control that part. You have much more control over how much you save. Here are my previous “saving for a decade” posts:

• January 2007 to December 2016
• January 2008 to December 2017
• January 2009 to December 2018

Work on improving your career skills (or start your own business), save a big chunk of your income, and then invest it in productive assets. Keep calm and repeat. Our path to financial freedom can be mostly explained by such behavior. The only “secret” here is consistency. We have maxed out both IRA and the 401k salary deferral limits nearly every year since 2004. No inheritances, no special access to a hedge fund. You can build serious wealth with something as accessible and boring as the Vanguard Target Retirement fund.

The financial news industry loves to provide constant updates of the S&P 500 along with endless guesses as to why it blipped up or down. I like reading about finance and it still drives me crazy! It just makes people focus on the short-term and think of the stock market like a roulette wheel. If you step back and take a longer-term view, here is a basic model for explaining the total return of the stock market:

Total Stock Returns = Earnings Growth + P/E Valuation Changes + Dividends

Here’s a quick common sense explanation:

Earnings growth. If your earnings stay the same, then all other things equal, one would expect the value of your company to stay the same as well. If earnings go up, again all other things equal, your company should be worth more, right?

Price-to-earnings ratio shows how much people are willing to pay as a multiple of earnings. When people are optimistic, the P/E ratio is high. When people are pessimistic, the P/E ratio is low. However, the overall ratio has some natural resistance points. A P/E of 10 means a 10% earning yield (ex. $100 share price and $10 of earnings per share). A P/E of 25 means a 4% earnings yield (ex. $100 share price and $4 of earnings per share).

Dividends. Cash money! In the long run, dividends tend to grow roughly at the same rate as earnings.

The WSJ Daily Shot used Bloomberg data to break down the performance of the S&P 500 total return by these components:

You can see that the dividend contribution has been pretty consistent at about 2% a year. Earnings have been going up the last 5 years, which is good news. Finally, we see that the P/E ratio has been a big part of the swings back and worth.

In The Little Book of Common Sense Investing, Jack Bogle called the changes in P/E ratio the “speculative return”, as opposed to something based on fundamentals. He made the following prediction about the future 10-year average return that book (originally published March 2007).

This was not meant to be an exact prediction. The main point was a warning that the future long-term returns were going to be lower than the historical returns of the last 25 years due to a lower dividend yield and somewhat elevated valuations. The annual return of Vanguard Total US Stock Market ETF (VTI) from March 2007 to March 2017 turned out to be 5.7%. According to the most recent quote (10/4/19), the average annual returns over the last 18 years has been 7%, last 15 years has been 9%, and the last 10 years has been 13%.

Bottom line. It can be educational to see the stock market return broken down into its parts: earnings growth, valuation change, and dividends. Much of the roller coaster performance we see every year is just the P/E ratio swinging back and forth. If you take a step back, you might find it easier to ignore the short-term volatility and focus on the long-term drivers of returns.

Vanguard has been relatively quiet after an SEC filing revealed their plans for a new digital-only advisory service called Vanguard Digital Advisor Services (VDAS). They have yet to send out any press releases or direct announcement about their new service. However, Vanguard is definitely working hard in the background on their advisory practices.

Earlier this month, they released a whitepaper called Assessing the Value of Advice based on their Vanguard Personal Advisor Services, which includes human advisors. They introduced a framework for measuring value via three components: portfolio, financial, and emotional.

Vanguard also published this short article Behind our passion for advice: Better outcomes for everyone that shows they want to impact the advice industry in the same way they forever changed the mutual fund industry.

Now more than ever, we see investors’ long-term success tied not only to the funds they use but also to the advice they receive. For more than 40 years, we’ve been champions in the mutual fund industry for accessibility, affordability, and alignment with clients’ interests. This has enabled investors to keep more of what they earn and to more easily reach their financial goals. We aim to do the same for financial advice.

This chart explores what a digital-only financial advisor can provide as compared to a human advisor:

With technology as our tailwind, opportunities abound to improve the ease of use, quality, and affordability of advice. Activities that once required time and effort from investors can now be automated and simplified. Rebalancing a portfolio, executing a tax-efficient spending strategy, or determining an optimal cash position can be done using algorithms and artificial intelligence. Technology has automated the common portfolio management tasks (the blue and the orange in the chart below). These core advice building blocks are more accurately and easily implemented than ever before, and technology allows us to provide them for less than 20 basis points. Even the most experienced and disciplined investor can benefit from advisory services at that price.

It certainly sounds like a description of Vanguard Digital Advisor Services (VDAS). I also hope they will more clearly define the added benefits of their Personal Advisor Services.