It’s easy to think about the stock market like it’s a retirement program. That’s certainly how it seems to function as you save toward that goal. Typically you’ve accumulated a lump sum and/or set up an automated contribution to your portfolio and are following a disciplined plan with the end goal of having a nest egg of sufficient size to replace your current income at some point in the future.
That’s certainly how it appears to the investor saving for retirement. But that’s not why the stock market exists or how it functions.
The market was created as an efficient way to provide capital for business. If a company can access money over and above what they are bringing in through current activity, it can pursue opportunities to expand operations, innovate their products, and potentially increase profits.
One way to get this expansion money is to borrow it from a bank. And most businesses do have a bank line of credit. But for a variety of reasons, including cost, companies will seek to tap into the financial markets by offering investors a fractional ownership stake in their business (stocks) or a lending position in their debt (bonds).
While investors are buying stocks or bonds in the market to get a return on their money, the enterprises they’re investing in are selling those securities to get capital. So, while publicly held companies want good returns for their shareholders, a huge jump in their stock price means that their future investors will eventually seek the same premium. And this tends to make a repetition of extraordinary gains less likely.
Marlena Lee, PhD and Wes Crill, PhD, senior investment executives at Dimensional funds give this example: The (so called) Magnificent 7 stocks grew by 76% in 2023. But is this a reasonable cost of equity capital? If these companies can secure funding at a lower rate through other means, they will. Which means that 76% is not likely to be a reasonable expected rate of return in the future.1
In other words, when a stock’s price is driven up by short-term investors who are hoping not to miss out on the next big thing, they are creating the conditions for that stock’s eventual decline. Because a stock is traded within a market for capital, it will tend to revert to market rates for that capital. For reference, across a century, the broad U.S. market has posted annualized returns averaging around 10%.
Given this tendency, Lee and Crill advise, “Rather than trying to guess which stocks might provide next year’s outsized returns, or getting caught up in a cycle of fear and greed, we believe it is better to set reasonable long-term expectations to track progress toward your financial goals.”
Setting your expectations on an extraordinary outcome that is less likely to reoccur can lead to disappointment and frustration. Given your investing timeline, your risk tolerance, and your unique financial situation, your trusted advisor can help you determine what that reasonable expectation should be.
If you ever have any questions about your investments or retirement plans, please feel free to give me a call at 801-545-0696.
Regards,
Mark Lund
Stonecreek Wealth Advisors, Inc.
11576 S State Street, Bldg. 1002
Draper, UT 84020
Sources:
1. http://go.pardot.com/e/91522/k-on-high-flying-stock-returns/958yjw/2383400216/h/47o2kBPu2MkN0X2GXAQNk0NUziV2TAf7_KEQrdFh6_g
Disclosure: This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This material was prepared by Efficient Advisors, LLC (“EA’) for Mark Lund, Mark is a Financial Advisor in Utah. He is known as a Wealth Advisor, The 401k Advisor, Investor Coach, Financial Planner, Investment Advisor and author of The Effective Investor. Mark offers investment advisory services through Stonecreek Wealth Advisors, Inc. a fiduciary, independent, fee-only, Registered Investment Advisor firm providing investment management and retirement planning for individuals and 401k consulting for small businesses. Mark’s newsletter is called The Effective Investor Newsletter. Cities served in Utah are: Salt Lake City, Salt Lake County, Utah County, Park City, Murray City, West Jordan City, Sandy City, Draper City, South Jordan City, Provo City, Orem City, Lehi City, Highland City, Alpine City, American Fork City. The views expressed herein are exclusively those of Efficient Advisors, LLC (‘EA’), and are not meant as investment advice and are subject to change. All charts and graphs are presented for informational and analytical purposes only. No chart or graph is intended to be used as a guide to investing. EA portfolios may contain specific securities that have been mentioned herein. EA makes no claim as to the suitability of these securities. Past performance is not a guarantee of future performance. Information contained herein is derived from sources we believe to be reliable, however, we do not represent that this information is complete or accurate and it should not be relied upon as such. All opinions expressed herein are subject to change without notice. This information is prepared for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. You should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. You should note that security values may fluctuate and that each security’s price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Investing in any security involves certain systematic risks including, but not limited to, market risk, interest-rate risk, inflation risk, and event risk. These risks are in addition to any unsystematic risks associated with particular investment styles or strategies.
