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Archive for Sunday, January 29, 2006

Check numbers before deciding how to invest

January 29, 2006

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If you've been investing for a while, you probably know the basic rule of thumb: Stocks are risky but have the best long-term performance; bonds are less risky but have lower returns; cash is safe but earns almost nothing.

The actual performance numbers are important in making assumptions about long-term investing - and how to divide your holdings among those three asset classes to balance risk and expected returns.

Here, then, are the up-to-date figures, for the past 80 years - from the start of 1926 to the end of 2005 - courtesy of market-data firm Ibbotson Associates. The figures are average annual returns, with compounding and all dividends reinvested:

¢ Large-company stocks, such as those in the Standard & Poor's 500 index, 10.4 percent.

¢ Small-company stocks, such as the smallest 20 percent traded on the New York Stock Exchange, 12.6 percent.

¢ Long-term government bonds, 5.5 percent. That includes interest payments, or yield, and bond price changes as interest rates fluctuate.

¢ Cash, represented by the 30-day Treasury bill, 3.7 percent.

Taking inflation - average: 3 percent - into account leaves you with less.

With cash, you'd barely tread water. If inflation took away 3 percentage points of your 3.7 percent return, you'd be left with pitiful gains of just 0.7 percent a year. It would take nearly 100 years for your buying power to double.

With a real return of 2.5 percent, money invested in long-term bonds would take 28 years to double in value.

Large stocks would take about 10 years to double, with small ones taking just over seven years.

Most mutual-fund companies and brokerages can offer advice on asset allocation, and you can find it online and in financial programs such as Quicken.

But remember: Automated programs are literal. If you tell the machine you're terrified of losing money, it may suggest you put too much of your holdings into bonds and cash, stunting your long-term growth.

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