With $300,000 invested in the stock market, you can make $20,000 in dividends. You can also lose $100,000 in a year, which happened in 2008. You can also lose $200,000 over the course of three years, which would have happened from 2000-2003. You can also only make 1-4%, which happened in 2011 and 2015.
So what is your strategy for those years to pay the mortgage? "Sorry Mr. Banker, the stock market crashed, I'll pay you in a few years once I get my money back though."
There's a reason that financial advisors tell people to move their funds away from the stock market post retirement. One bad year and your income will be cut drastically.
Sorry for the late reply. A football game and some other stuff got in the way.
Ah, risk... a much more interesting discussion. All your points above are true. The stock market is not without risk. However, I think it is a prudent risk going forward. Whether you agree with
Thomas Piketty regarding returns to capital vice labor, or you agree with Elon Musk about the dangers of Artificial Intelligence, I believe it is important to be an owner of capital. If robots are doing most of our jobs in the future, don't you want to own the company that owns the robots/algorithms? I do.
Your strategy is not risk-less. What about the people living in
Detroit that paid off their houses early then saw their value plummet? I bet they wish they could walk away with an extra pile of $$$$ in some kind of account and give the house back to the bank. What about using that extra money to buy an investment property in another city with positive cash flow in year 1? When the factory closes in your town you won't be hosed with your entire net worth rolled into 1 asset.
You are correct about market drops. If someone is about to retire, by all means increase that bond allocation. However, if you are just a bad market timer, do not frett, just leave the money in and you will be OK. Here's an interesting story about the
world's worst market timer.
Yes, annual lump sum investing is an assumption in the model, but really it's not very significant - maybe like $20,000 off after 40 years at your 8% margin rate and really the final difference in numbers are an order of magnitude higher. I assumed end of year investing because as a brand-new 0-1 you haven't been paid yet. The amount of time it would take to build a monthly model vice an annual one isn't really worth the squeeze- that spreadsheet took me 15 minutes and a monthly one would take me at least an hour.
The bigger problem with it is that 100 * 1.07 * 1.07 =/= 100 * .93 * 1.14. A true model would be stochastic and choose a random variable with a mean of 7%, adjusted for the percent invested in the stock market, and then average 30 or so trials. This is actually easier to do than calculating a monthly model.
But you can smooth all of that out by just lowering your overall assumption of average compounding, which is why I keep telling you that your 7-8% average is a pipe dream. I can nearly guarantee you that sometime in the next 20 years the stock market is going to lose nearly half its value again.
Regarding the random variable, that would add greater realism to the model, but only if we could be confident about the distribution of that random variable. Is it normally distributed along a bell curve like natural phenomena, i.e. heights of humans? Or is it some other distribution? For example, consider a random group of 100 people, then add Bill Gates to the group. Did the average height change much? No. How about the average net worth? Changed a lot. As a comparison, adding an 8' tall man wouldn't really change the average height of a group of 100 people as much. Long Term Capital Management assumed financial market movements were normally distributed, then they got hit with what they assessed to be a 10 sigma event (extremely rare, maybe once in 1 trillion years or so). Maybe their assessment of probability was off. Maybe they were really unlucky. You decide. Nassim Nicholas Taleb and his books "
Black Swan" and "
Fooled by Randomness" do a great job of arguing against normal distribution in financial markets for anyone who is interested. Interesting discussion, and no model is ever
perfect, or else it would be called reality and not a model.
I'm not quoting 7-8%. Many pension funds out there are banking on 7.x% returns in order to meet their obligations, and they are probably wrong. Something with a 6 handle is probably more likely. Lots of articles in the financial press lately about overly rosy pension expectations. I made a point earlier that if I only need to beat a 3.5% hurdle (your insanely low mortgage rate) I can be more conservative and decrease my expected future volatility. I would maybe put together a 50/50 bond and stock portfolio, which will dramatically lower expected volatility. Voila, less risk. When you try to hit home runs every at bat, you are more likely to strikeout occasionally. If you are only looking for walks or singles, you are likely to have a much higher on base percentage.
