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Authors: Peter Lynch
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this analysis a step further, you realize that theoretically it makes no sense to put any money into bonds, even if you do need income. This radical conclusion comes from another set of numbers I asked Beckwitt to crunch. The result is shown here in Table 3-2 .
Letâs say you have $100,000 to invest, and have determined that you need to make $7,000 in income to maintain your standard of living. The commonsense advice given to people who need income is to buy bonds. But instead, you veer off in a wild and crazy direction and turn the $100,000 into a portfolio of stocks that pay a combined 3 percent dividend.
TABLE 3-1. RELATIVE MERITS OF STOCKS VERSUS BONDS
Table 3-2. 100% STOCKS INVESTMENT STRATEGY
Begin with 3% dividend on stocks; assume 8% growth in dividends and in stock prices; spend a minimum of $7,000*
During the first year, your 3 percent dividend puts $3,000 into your account. Thatâs not enough income. How do you cover this shortfall? You sell $4,000 worth of stock. If your stock prices have gone up at the normal rate of 8 percent, the portfolio will be worth $108,000 at the end of the year, so your $4,000 dip into capital leaves you with $104,000.
The second year, the dividend income from the portfolio has increased to $3,120, so you only have to sell $3,880 worth of stock. Every year thereafter, the dip into capital gets smaller and the dividendsget larger, until the 16th year, when the portfolio produces more than $7,000 in income from your dividend checks alone. At this point, you can maintain your standard of living without having to sell a single share.
At the end of 20 years, your original $100,000 has grown into $349,140, and youâre nearly four times richer than you were when you started, in addition to your having spent $146,820 worth of income along the way.
Once and for all, we have put to rest the last remaining justification for preferring bonds to stocksâthat you canât afford the loss in income. But here again, the fear factor comes into play. Stock prices do not go up in orderly fashion, 8 percent a year. Many years, they even go down. The person who uses stocks as a substitute for bonds not only must ride out the periodic corrections, but also must be prepared to sell shares, sometimes at depressed prices, when he or she dips into capital to supplement the dividend.
This is especially difficult in the early stages, when a setback for stocks could cause the value of the portfolio to drop below the price you paid for it. People continue to worry that the minute they commit to stocks, another Big One will wipe out their capital, which they canât afford to lose. This is the worry that will keep you in bonds, even after youâve studied Tables 3-1 and 3-2 and are convinced of the long-range wisdom of committing 100 percent of your money to stocks.
Letâs assume, then, that the day after youâve bought all your stocks, the market has a major correction and your portfolio loses 25 percent of its value overnight. You berate yourself for gambling away the family nest egg, but as long as you donât sell, youâre still far better off than if youâd bought a bond. Beckwittâs computer run shows that 20 years later, your portfolio will be worth $185,350, or nearly double the value of your erstwhile $100,000 bond.
Or letâs imagine an even worse case: a severe recession that lasts 20 years, when instead of dividends and stock prices increasing at the normal 8 percent rate, they do only half that well. This would be the most prolonged disaster in modern finance, but if you stuck with the all-stock portfolio, taking out your $7,000 a year, in the end youâd have $100,000. This still equals owning a $100,000 bond.
I wish Iâd had Beckwittâs numbers when I made my presentation to the nonprofit organization weâve been talking about, because thenI might have tried to talk them out of owning any bonds. At least we decided to increase
Letâs say you have $100,000 to invest, and have determined that you need to make $7,000 in income to maintain your standard of living. The commonsense advice given to people who need income is to buy bonds. But instead, you veer off in a wild and crazy direction and turn the $100,000 into a portfolio of stocks that pay a combined 3 percent dividend.
TABLE 3-1. RELATIVE MERITS OF STOCKS VERSUS BONDS
Table 3-2. 100% STOCKS INVESTMENT STRATEGY
Begin with 3% dividend on stocks; assume 8% growth in dividends and in stock prices; spend a minimum of $7,000*
During the first year, your 3 percent dividend puts $3,000 into your account. Thatâs not enough income. How do you cover this shortfall? You sell $4,000 worth of stock. If your stock prices have gone up at the normal rate of 8 percent, the portfolio will be worth $108,000 at the end of the year, so your $4,000 dip into capital leaves you with $104,000.
The second year, the dividend income from the portfolio has increased to $3,120, so you only have to sell $3,880 worth of stock. Every year thereafter, the dip into capital gets smaller and the dividendsget larger, until the 16th year, when the portfolio produces more than $7,000 in income from your dividend checks alone. At this point, you can maintain your standard of living without having to sell a single share.
At the end of 20 years, your original $100,000 has grown into $349,140, and youâre nearly four times richer than you were when you started, in addition to your having spent $146,820 worth of income along the way.
Once and for all, we have put to rest the last remaining justification for preferring bonds to stocksâthat you canât afford the loss in income. But here again, the fear factor comes into play. Stock prices do not go up in orderly fashion, 8 percent a year. Many years, they even go down. The person who uses stocks as a substitute for bonds not only must ride out the periodic corrections, but also must be prepared to sell shares, sometimes at depressed prices, when he or she dips into capital to supplement the dividend.
This is especially difficult in the early stages, when a setback for stocks could cause the value of the portfolio to drop below the price you paid for it. People continue to worry that the minute they commit to stocks, another Big One will wipe out their capital, which they canât afford to lose. This is the worry that will keep you in bonds, even after youâve studied Tables 3-1 and 3-2 and are convinced of the long-range wisdom of committing 100 percent of your money to stocks.
Letâs assume, then, that the day after youâve bought all your stocks, the market has a major correction and your portfolio loses 25 percent of its value overnight. You berate yourself for gambling away the family nest egg, but as long as you donât sell, youâre still far better off than if youâd bought a bond. Beckwittâs computer run shows that 20 years later, your portfolio will be worth $185,350, or nearly double the value of your erstwhile $100,000 bond.
Or letâs imagine an even worse case: a severe recession that lasts 20 years, when instead of dividends and stock prices increasing at the normal 8 percent rate, they do only half that well. This would be the most prolonged disaster in modern finance, but if you stuck with the all-stock portfolio, taking out your $7,000 a year, in the end youâd have $100,000. This still equals owning a $100,000 bond.
I wish Iâd had Beckwittâs numbers when I made my presentation to the nonprofit organization weâve been talking about, because thenI might have tried to talk them out of owning any bonds. At least we decided to increase
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