Although it might appear that the stock market is well above where it was in 2007 before the crash, the question that remains to be answered is “Are we really above even?”
Given that the old high for the Dow Jones Industrial Average was around 13930 in October 2007, and today we are well above 16,800, at first glance it would be undeniable that we are up but there is one part of the break-even equation that is missing. Let me explain.
Let’s say in 2007 at the peak of the market (DJIA 13930) Mary and Bill both had 100k invested in their 401k’s in an index fund that imitated the DJIA (aka. an ETF). And let’s assume that Mary decided to sell everything at the peak of the market and spend that money on goods and services like food, healthcare, travel, college tuition and maybe fuel for her car. But Bill decided to stay the course and ride out the storm at the advice of his advisor who believed in the theory of buy and hold investing.
Given that the market (as of this writing) is currently about 20% higher than the old high from 2007, it would seem that Bill (and his advisor) took the more bountiful path and Mary missed out…or did she?
The one fact that this story is missing is a big one. During the time when Bill was waiting to break even (2007-2012), our old nemesis “Mr. Inflation” was hard at work. And thanks to Mr. Inflation and his sneaky ways of stealing our money, the cost of the goods and services that Mary enjoyed back in 2007 are no longer 100k.
In fact, if real inflation was only 3% annually between 2007 and 2014 (it was much higher), those same goods and services would cost Bill almost $123,000 today! Put another way, the Dow Jones Industrial Average would have to be 17,312 today for Bill to cash out and buy the same goods and services that Mary enjoyed back in 2007 assuming only a 3% increase in cost of living.
In reality, the real rate of inflation for food, fuel, health care and college tuition for America’s top 10 largest cities ranged between 8.7% and 12.8% just in the last 3 years! This data comes from the Chapwood Index which tracks the real cost of living based on real data from consumers surveyed around the country from 50 major cities.
If we apply the Chapwood data for the top 10 cities on the low end, and assume prices rose by only 8% per year over the last 6 years, the same goods and services that Mary bought for 100k in 2007 would cost Bill over 160k today. Put another way, the Dow would have to be over 22,100 just to equal what it was back in 2007 before the crash.
So the moral of this story is simple. The world does not stop spinning nor does inflation stop stealing your money just because you are waiting to break even on your losses. This is why the 3 golden rules of successful investing are so important and need to be taken seriously:
- Don’t lose money
- Don’t lose money
- See rule 1 and 2
In other words, when it comes to your serious money, the money that you will one day depend on to replace the income from your job in order to live out your years as an unemployed retired person, it is crucial that you avoid participating in the downside when things fall apart like they always eventually do.
Simply put, it is much easier to have success with modest returns on money that never goes backwards than it is to have success getting higher returns on money that is subject to large losses.
And although Wall Street would like you to believe that such an approach does not exist, the truth is that it does exist and has for decades.