Don’t Put All of Your Eggs Into One Basket

Written By Tommy Parisi

Let me begin with this disclosure: I am not a Certified Financial Planner.

This may discredit the following blog as I do not hold special certifications, or it may provide some comfort as I do not make my living off the fees associated with managing one’s money. I did however graduate High School (College too, but that’s not important here) and have a firm comprehension of basic Math. This post is in relation to my personal Financial Journey, and I am sharing these findings with you, the reader.

In my opinion, the CFP (Certified Financial Planner) is an invaluable tool for those without the acumen or time to comprehend basic financial literacy. I believe there are many CFPs out there with exceptional skills, industry knowledge and the heart to do right by their clients.

I feel that if one is willing to invest (pun absolutely intended) the time, a bookstore and the world wide web are full of credible sources to empower one to manage their own finances.

I value the power of compound interest. The great Albert Einstein once said: “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays it”.

Since I joined the labor force nearly 18 years ago, I have subscribed to this notion. Living through several economic cycles and observing the swings has challenged me to reevaluate this “eighth wonder” and the foundations for which it is applied.

I’ve always been a by the book kind of a guy: Max out your 401(k), take advantage of a ROTH IRA, start your children’s 529 account as soon as possible, pay down debt etc. I’ve read several books about these concepts and spent countless hours on podcasts sharpening these skills. Many individuals and institutions have made insurmountable piles of income by telling you how to invest yours. Reflecting on the last 18 years has cause me to reevaluate these notions.

When my children were born, I started their 529 account(see below at California Scholarshare for explanation) the day their social security cards showed up in the mail. I watched their account grow and felt secure about the astronomical fees I may pay if they choose to attend college in 2034.

Within a few months, I watched my children’s 529 account drop 30%.... because hey, the market goes up and down.

The problem: college tuition does not adjust accordingly to the stock market. Nor do retirement expenses when I turn 65 in 2047.

So why am I putting all my eggs into one basket?

Stock Market Fallacy:

According to Investopedia.com, The S&P index has returned a historic annualized average return of around 11.88% since its 1957 inception through the end of 2021. The S&P 500 index acts as a benchmark of the performance of the U.S. stock market overall, dating back to the 1920s (in its current form, to the 1950s). Adjusted for inflation, the historical average annual return is only around 8.5%.

So you’re saying that, in theory, I can purchase a low expense ratio fund representing the cumulative S&P 500 and count on an 8.5% average annual return? That sounds as foolproof as cooking with sous vide (see “Why You Need to Sous Vide” 12/28). 

The problem is that 8.5% is not as simple as it sounds. An 8.5% average annual return does not mean that you will grow 8.5% year over year, it’s a true average over the history of the S&P 500.

Depending on when you enter or exit the market, you could experience significant fluctuations in the value of your holdings. Don’t believe me? Ask an individual who retired (or attempted to retire) in 2008 when the S&P 500 tanked 36.55%.

I’m a visual learner. For those of you like me, here is a visual representation of the point stated above.

Observe the table below which shows year over year 8.5% returns on your investment of $100,000.

Now, let’s look at another table. In this scenario, one is still earning an average of 8.5% return after 5 years. However, the results are not quite the same.

Pay attention to the market fluctuations affecting the Rate of Return

In scenario #2, the investor finished with $2,505.13 less money than in scenario #1. These investments both started with the same amount of initial capital and had an 8.5% average return. How can this happen?

Note: these are simple numbers. This does not account for taxes and brokerage fees paid (another thing to consider when putting all your investment eggs into the stock market basket).

The returns could have been further skewed to reveal an even more drastic discrepancy between both scenarios. I’m playing devils advocate here. So what’s going on? 

The market is not linear

It is constantly going up and down, despite historic growth. Depending on when you enter and exit the market, you may experience different outcomes. 

Graft image taken from https://www.macrotrends.net/2324/sp-500-historical-chart-data

FACT: returns have fluctuated through the course of history and will continue to do so in the future. This is inarguable.

The “average return” that sells individuals on why to invest in the S&P 500 is a historic average. Nobody has a crystal ball and can accurately predict the next 40 years of returns, nobody.

Where do we go from here?

As stated above, I am not a Certified Financial Planner. By no means should you take my musings as investment scripture. The purpose of this blog is to inspire thought and reflection.

It was my thought and reflection on finances in the Post-COVID world that lead me to the following conclusion: maybe I shouldn’t be a “by the book kind of a guy”.

There is more than one basket to place your eggs in. In the investment circle, the saying: “diversification is key” is often spoken to mitigate risk. Maybe it’s time for you to learn about the other baskets out there for you to diversify in to. 

In future posts, I will my share my research on these alternative baskets for you to diversify in to. As is the spirit of this blog, my hope is to provide just enough information about it for you to make your own, educated decision and share additional resources to further your knowledge.

“An investment in knowledge pays the best interest”
-Benjamin Franklin 

There may be a reason why he’s on the $100 bill!

Tommy Parisi https://www.enoughaboutit.com
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