Author Topic: Index Returns  (Read 4647 times)

pogoslayer

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Index Returns
« on: June 24, 2015, 03:28:35 PM »
Hi, I've recently stumbled across this blog and have been reading it quite a bit. I'm 20 years old a little financially illiterate and have decided to follow this ideology, which do not work well together. I've not incurred any debt in my life (yet) and am half way through with university. i'm currently working for a bank in the IT department and am doing my best to dedicate 80% of my pay to the VTI index, but have a question regarding it.

My question for my fellow mustacians is this: How do "returns" work for index funds. I simply do not understand the concept of a 7% return. Does this mean the price of the share increases ~7% annually in the long term or is it that you're rewarded 7% as a dividend annually. I appreciate any and all response.
« Last Edit: June 24, 2015, 03:32:14 PM by pogoslayer »

milesdividendmd

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Re: Index Returns
« Reply #1 on: June 24, 2015, 03:44:16 PM »
returns = dividends + appreciation in the price of the stocks owned.

Indexer

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Re: Index Returns
« Reply #2 on: June 24, 2015, 05:13:19 PM »
Hi, I've recently stumbled across this blog and have been reading it quite a bit. I'm 20 years old a little financially illiterate and have decided to follow this ideology, which do not work well together. I've not incurred any debt in my life (yet) and am half way through with university. i'm currently working for a bank in the IT department and am doing my best to dedicate 80% of my pay to the VTI index, but have a question regarding it.

My question for my fellow mustacians is this: How do "returns" work for index funds. I simply do not understand the concept of a 7% return. Does this mean the price of the share increases ~7% annually in the long term or is it that you're rewarded 7% as a dividend annually. I appreciate any and all response.

Well it depends on the index fund.  There are bond funds and stock funds.

This might be a good starter read:  https://personal.vanguard.com/us/insights/investingprinciples

So lets use the Vanguard 500 index as an example.  It tracks the S&P 500 index, and it was the first major index fund available to investors.  Whatever the index does, that is probably what your index fund will do.  Your return isn't all dividends.  When you own stocks they can appreciate in value & you can get dividends.  Lets look at the returns of the Vanguard 500 index.

2014: 11.46% growth + 2.18% dividend = 13.64% return
2013: 29.68% growth + 2.65% dividend = 32.33% return
2012: 13.45% growth + 2.52% dividend = 15.96% return
...
2008: -38.52% growth + 1.55% dividend = -36.97% return

Now if you want to be 100% stocks you need to have the discipline to be able to handle the good and the bad.  You have to be ok watching a 37% drop.  Actually you need to LOVE a 37% drop because everything is on sale.  If my last sentence sounds crazy you shouldn't be 100% stock.  On the link I provided above under principle #2 balance there are some great charts for helping you pick the ratio of stocks[risky] to bonds[safe] to build the perfect portfolio for you.

Cycling Stache

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Re: Index Returns
« Reply #3 on: June 24, 2015, 06:45:45 PM »
You're 20.  Now is a PERFECT time to be 100% stocks.  Just think of the money as a one-way street.  Money only goes into that account.  You can revisit that decision in 10-15 years.

So the key is that for each dollar you put in, think, do I really need that money?  Will my life be horrible if I don't have it.  If the answers are no and no, put it in the market, and thank yourself 15 years in the future.

As others said, the rate of return is the increase in value in your portfolio, which typically includes dividends (the default on Vanguard is to reinvest dividends by buying additional funds--at least for the index fund, not sure about ETF).  But as mentioned above, it will be very volatile along the way.  Some years up--and maybe way up, some years down--and maybe way down.  But on average over many years, stocks tend to return an average of 7% per year, which is very good over the long-term.

So put money there if you don't need it, and be happy living on less.  You will be very, very, very happy with that decision when you're older if you've stuck to it.

pogoslayer

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Re: Index Returns
« Reply #4 on: June 24, 2015, 07:17:57 PM »
You're 20.  Now is a PERFECT time to be 100% stocks.  Just think of the money as a one-way street.  Money only goes into that account.  You can revisit that decision in 10-15 years.

So the key is that for each dollar you put in, think, do I really need that money?  Will my life be horrible if I don't have it.  If the answers are no and no, put it in the market, and thank yourself 15 years in the future.

As others said, the rate of return is the increase in value in your portfolio, which typically includes dividends (the default on Vanguard is to reinvest dividends by buying additional funds--at least for the index fund, not sure about ETF).  But as mentioned above, it will be very volatile along the way.  Some years up--and maybe way up, some years down--and maybe way down.  But on average over many years, stocks tend to return an average of 7% per year, which is very good over the long-term.

So put money there if you don't need it, and be happy living on less.  You will be very, very, very happy with that decision when you're older if you've stuck to it.

Thank you, by reading your post it would appear that I need to actually be into say VTSAX and keep adding for awhile. Now onto my continuing confusion. If the dividends of my account are above the current $53.56 that the fund is now it will purchase more of the fund? How are the funds withdrawn in the 10-15 years latter in life? Just sell the shares? Also should these be going into an IRA or just a regulAr account? Thank you all again for your aid.
« Last Edit: June 24, 2015, 07:43:47 PM by pogoslayer »

Indexer

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Re: Index Returns
« Reply #5 on: June 24, 2015, 08:00:49 PM »
You're 20.  Now is a PERFECT time to be 100% stocks. 

Yes... IF he can handle the volatility.  Mathematically everyone should be 100% stock in their 20s.  However most investors lack the discipline to ride that roller coaster to the bottom of the bear.  It is very EASY to say one has that discipline in the middle of a long bull market.  When the market is down 40% and the news is saying it could go to zero some people lose their faith in their strategy.  In my experience the people who can handle 100% stock are very knowledgeable investors who truly understand the extra risk they are taking and will keep on buying no matter how low the market goes.  The difference in average annual returns between a 70/30 portfolio(9%year) and 100% stock(10%year) is about 1% returns per year, but the volatility difference can be extreme.  A 70/30 will normally see less than 1/3 drop in a crisis where a 100% stock portfolio could see a 40 to 50% drop in a crisis or looking back to the great depression the Dow dropped 89%.

Source: https://en.wikipedia.org/?title=Stock_market_crash#Wall_Street_Crash_of_1929

Thank you, by reading your post it would appear that I need to actually be into say VTSAX and keep adding for awhile. Now onto my continuing confusion. If the dividends of my account are above the current $53.56 that the fund is now it will purchase more of the fund? How are the funds withdrawn in the 10-15 years latter in life? Just sell the shares? Thank you all again for your aid.

With mutual funds you can buy fractional shares.  So if you add $100 and the shares are 53.56 you will actually add 1.8671 shares. When you need the money you would sell the shares. 

VTSAX is a great fund, but it is only US stocks.  You can combine it with VTIAX to get some international stock.  If you want an easy button there are also the Target Retirement funds and LifeStrategy funds.

pogoslayer

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Re: Index Returns
« Reply #6 on: June 24, 2015, 08:42:46 PM »
So in this example

Quote
With mutual funds you can buy fractional shares.  So if you add $100 and the shares are 53.56 you will actually add 1.8671 shares. When you need the money you would sell the shares. 

If the market were to go down 89% then so would the stock price of the index. You'd be waiting for the index to recover to start the profitable returns? I guess what I'm getting at is, if the market crashed how boned would index holders be if they were living off the 7% return.

10-15 years with auto deposits wouldn't be bad even during a rough patch. However, what would it be like if the rough patches happened post 15 years during early retirement.

I'm sure that all reads like nonsense, I was unsure how to form my questions though, sorry.

pogoslayer

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Re: Index Returns
« Reply #7 on: June 25, 2015, 08:42:56 AM »
Bump. Also while I have the attention of the community. Where can I put my soldiers to work while I save up to the minimum to enter a fund?
« Last Edit: June 25, 2015, 10:10:36 AM by pogoslayer »

Indexer

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Re: Index Returns
« Reply #8 on: June 26, 2015, 04:03:55 PM »
The ETF shares have a lower minimum.

Look at VTI and VXUS.

Jeremy E.

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Re: Index Returns
« Reply #9 on: June 26, 2015, 04:18:18 PM »
Bump. Also while I have the attention of the community. Where can I put my soldiers to work while I save up to the minimum to enter a fund?
ETF's might be a good idea, I've never tried them myself, heres a post from MMM
http://www.mrmoneymustache.com/2011/06/07/where-should-i-invest-my-short-term-stash/
Also once you hit 1k I believe you can open a target retirement fund through Vanguard, once you hit 3k you can go for VTSMX and then at 10k up to VTSAX, VTSMX should automatically turn into VTSAX once you cross the 10k threshold.

Hi, I've recently stumbled across this blog and have been reading it quite a bit. I'm 20 years old a little financially illiterate and have decided to follow this ideology, which do not work well together. I've not incurred any debt in my life (yet) and am half way through with university. i'm currently working for a bank in the IT department and am doing my best to dedicate 80% of my pay to the VTI index, but have a question regarding it.

My question for my fellow mustacians is this: How do "returns" work for index funds. I simply do not understand the concept of a 7% return. Does this mean the price of the share increases ~7% annually in the long term or is it that you're rewarded 7% as a dividend annually. I appreciate any and all response.
I recommend you put $5500 into a Roth IRA before doing any investing in a normal taxable account.
https://investor.vanguard.com/ira/how-to-open-an-ira
The default will be for the dividends to automatically buy partial shares.
I recommend VTSMX, I've personally never invested in ETFs so I'm not sure how they work.
Good Luck!

forummm

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Re: Index Returns
« Reply #10 on: June 27, 2015, 06:23:59 PM »
I guess what I'm getting at is, if the market crashed how boned would index holders be if they were living off the 7% return.

You would be pretty darn boned, if you were living off the 7% returns, but this is not the best vehicle for income generating, IMHO. It may be a good one to build wealth, however, which should be your current goal.

No one should expect a 7% withdrawal rate to last very long. I'm not sure if that's what was meant because the question wasn't very clear. If you want to learn more about withdrawal rates, check out some reasons why the 4% withdrawal rate is the one that people commonly rely on.
http://forum.mrmoneymustache.com/investor-alley/stop-worrying-about-the-4-rule/

Cycling Stache

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Re: Index Returns
« Reply #11 on: June 27, 2015, 06:27:03 PM »
I guess what I'm getting at is, if the market crashed how boned would index holders be if they were living off the 7% return.

You would be pretty darn boned, if you were living off the 7% returns, but this is not the best vehicle for income generating, IMHO. It may be a good one to build wealth, however, which should be your current goal.

No one should expect a 7% withdrawal rate to last very long. I'm not sure if that's what was meant because the question wasn't very clear. If you want to learn more about withdrawal rates, check out some reasons why the 4% withdrawal rate is the one that people commonly rely on.
http://forum.mrmoneymustache.com/investor-alley/stop-worrying-about-the-4-rule/

I'm guessing the commenter meant counting on the expected 7% market returns.  That's how I read it.

forummm

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Re: Index Returns
« Reply #12 on: June 27, 2015, 06:31:27 PM »
I guess what I'm getting at is, if the market crashed how boned would index holders be if they were living off the 7% return.

You would be pretty darn boned, if you were living off the 7% returns, but this is not the best vehicle for income generating, IMHO. It may be a good one to build wealth, however, which should be your current goal.

No one should expect a 7% withdrawal rate to last very long. I'm not sure if that's what was meant because the question wasn't very clear. If you want to learn more about withdrawal rates, check out some reasons why the 4% withdrawal rate is the one that people commonly rely on.
http://forum.mrmoneymustache.com/investor-alley/stop-worrying-about-the-4-rule/

I'm guessing the commenter meant counting on the expected 7% market returns.  That's how I read it.

I was referring to the OP's question, which the commenter didn't highlight. I bolded it here.

If the person has a 4% SWR, they'd probably be OK if the market crashed--that's built into the 4% calculation. If they were spending 7%, they'd probably be pretty "boned".