WALL STREET MATH
By Michael Goodman
On January 1, 1984, the S&P 500 stood at $164.93. Over the next 30 years,
it grew to $1,848.36. The annual returns were: (read down the first column, down the second column, etc)
| 1984 – 1.4% | 1994 – -1.5% | 2004 – 9.0% |
| 1985 – 26.3% | 1995 – 34.1% | 2005 – 3.0% |
| 1986 – 14.6% | 1996 – 20.3% | 2006 – 13.6% |
| 1987 – 2.0% | 1997 – 31.0% | 2007 – 3.5% |
| 1988 – 12.4% | 1998 – 26.7% | 2008 – -38.5% |
| 1989 – 27.3% | 1999 – 19.5% | 2009 – 23.5% |
| 1990 – -6.6% | 2000 – -10.1% | 2010 – 12.8% |
| 1991 – 26.3% | 2001 – -13.0% | 2011 – -0% |
| 1992 – 4.5% | 2002 – -23.4% | 2012 – 13.4% |
| 1993 – 7.1% | 2003 – 26.4% | 2013 – 29.6% |
If you total these up and divide by 30, you will get an average return of 9.84%
(not including dividends). But did the S&P 500 actually grow at a rate of
9.84%? Using my HP Business calculator to do the time value of money calculation,
I find that when $164.93 grows to $1,848.36 over 30 years, the actual annualized
rate of growth is 8.39%. What’s up?! Why is the actual growth rate 1.5% LESS
than the average rate? The answer is Wall Street Math.
Anytime you average a series of numbers that includes negative numbers, this
problem will arise. Just think about this simplified example. If you invest
$100 and it goes up 10% in the first two years, then goes down 20% in the third
year, what is your rate of growth? The AVERAGE of these three years is zero%
(10, 10, -20 = 0/3= 0%). But did your investment actually break even? NO! Your
$100 goes up 10% to $110 after one year; goes up 10% to $121 after two years;
then goes down 20% to $96.80 after the third year. You lost $3.20 over the three
years, a “growth” rate of -1.07%. When an investment goes down by
ANY amount, it must go up a HIGHER percentage to break even. If a $100 investment
goes down 20%, you now have $80, right? It now needs to go up by 25% just to
break even ($20/$80 = 25%).
The point of this is that it’s not unusual to hear Wall Street guys talk about
the average growth rate of the market over a period of time. BEWARE of averages
used to describe the growth rate of securities when there is a chance of loss.
Those numbers are NOT accurate.
How does this apply to your retirement and IUL’s (indexed universal life policies)?
If you turn all of those red negative numbers above into zeros, then change
the growth numbers that are larger than 14.5% into a 14.5 and average the numbers,
you get the growth rate of an IUL with a cap of 14.5% and a guaranteed floor
of 0%. That growth rate was 8.56% during the same years that the S&P 500
was growing at 8.39%.
Keep in mind that all IUL’s are not the same. Just as your investments in the
market have costs and fees, part of the premium paid for an IUL also goes to
fees and the cost of insurance. Every company charges different amounts for
the cost of insurance and other fees, and many companies have caps that are
less than 14.5%. To get an IUL with the lowest costs from a strong carrier, your agent must work with the right insurance companies and he’s got to know how to design a policy that
maximizes growth of the cash value.
The only way to know how an IUL compares to other financial options is to speak
with a good agent and get a quote/illustration. If you’re in the state of California,
send me a note HERE.
Michael Goodman
Life Insurance Agent in Santa Clarita, CA