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Which Would You Prefer?
Old 02-12-2007, 06:03 PM   #1
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Which Would You Prefer?

Plan A: you invested a sum in equities, and over the next four years your annual total returns were 20%, 5%, 15% and -20%.

Plan B: You buy a 4 year CD at 4% with annual compounding.

Which plan leaves you with more money at end of year 4?

Ha

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Re: Which Would You Prefer?
Old 02-12-2007, 06:08 PM   #2
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Re: Which Would You Prefer?

And the question is?

I can't wait the hear the correct answer.
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Re: Which Would You Prefer?
Old 02-12-2007, 06:09 PM   #3
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Re: Which Would You Prefer?

I'd need to know what P/E10 was at the end of year 3.

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Re: Which Would You Prefer?
Old 02-12-2007, 06:10 PM   #4
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Re: Which Would You Prefer?

The first case leaves you with 1.16 times your original investment.

The second case leaves you with 1.17 times your original investment.

Interesting. I bet most people would choose the first one w/o doing the math
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Re: Which Would You Prefer?
Old 02-12-2007, 06:10 PM   #5
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Re: Which Would You Prefer?

Quote:
Originally Posted by HaHa
Plan A: you invested a sum in equities, and over the next four years your annual total returns were 20%, 5%, 15% and -20%.

Plan B: You buy a 4 year CD at 4% with annual compounding.

Which plan leaves you with more money at end of year 4?

Ha

Mikey,

Knowing you I knew the answer was going to be CD's, because you dislike stocks currently. But, I worked the math and yes the CD's win by a buck or 2.
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Re: Which Would You Prefer?
Old 02-12-2007, 06:11 PM   #6
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Re: Which Would You Prefer?

If I knew the stock market would do that and I'd cash out exactly in 4 years, I'd take the CD and triple my profits.

However, being only 29 I'm in for the long-haul I'd jam as much into equities.... that's why there's 0% bonds in my 401k.
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Re: Which Would You Prefer?
Old 02-12-2007, 06:26 PM   #7
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Re: Which Would You Prefer?

Quote:
Originally Posted by Cut-Throat
Mikey,

Knowing you I knew the answer was going to be CD's, because you dislike stocks currently. But, I worked the math and yes the CD's win by a buck or 2.
C-T, good analysis, of me and the numbers.

Actually though, I was messing around with the concept of geometric mean (GEOMEAN in Excel). Although I vaguely understood it I recently got more interested because Dimson refers to it often.

It is kind of counterintuitive- those stock returns seem pretty good, but even a middling bad year hurts.

Ha
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Re: Which Would You Prefer?
Old 02-12-2007, 06:28 PM   #8
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Re: Which Would You Prefer?


Damn, I KNEW I shoulda put everything in those Penfed 6.25% CDs !

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Re: Which Would You Prefer?
Old 02-12-2007, 06:32 PM   #9
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Re: Which Would You Prefer?

Quote:
Originally Posted by HaHa
C-T, good analysis, of me and the numbers.

Actually though, I was messing around with the concept of geometric mean (GEOMEAN in Excel). Although I vaguely understood it I recently got more interested because Dimson refers to it often.

It is kind of counterintuitive- those stock returns seem pretty good, but even a middling bad year hurts.

Ha
That's why I think re-balancing plays an important role.
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Re: Which Would You Prefer?
Old 02-12-2007, 08:08 PM   #10
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Re: Which Would You Prefer?

Quote:
That's why I think re-balancing plays an important role.
it might indeed be worth noting that with these returns, if one split 50-50 and rebalanced at the end of each year, the return would exceed either of the two individual (buy and hold) alternatives.
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Re: Which Would You Prefer?
Old 02-12-2007, 08:14 PM   #11
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Re: Which Would You Prefer?

I'd have sold after year #3.
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Re: Which Would You Prefer?
Old 02-12-2007, 08:17 PM   #12
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Re: Which Would You Prefer?

In case 1, you're up 16% after 4 years.
In case 2, you're up 17% after 4 years.

So, the CD would have done better, in this case.

But chances of the market rebounding 20% in year 5 is really good!

Audrey
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Re: Which Would You Prefer?
Old 02-12-2007, 08:20 PM   #13
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Re: Which Would You Prefer?

Quote:
Originally Posted by Cute Fuzzy Bunny
I'd have sold after year #3.
Me too! And save myself a few minutes of math.

Now, what do I have to do to know ahead of time how well my investment will do? And I'm not talking about yearly performance. I wan't the daily numbers. I'm projecting 100 to 200% return per year.

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Re: Which Would You Prefer?
Old 02-12-2007, 08:21 PM   #14
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Re: Which Would You Prefer?

Quote:
Originally Posted by HaHa
It is kind of counterintuitive- those stock returns seem pretty good, but even a middling bad year hurts.
Interesting exercise. For me the biggest message is if you are accepting volatility in return for long term rewards, make sure you hold long term.
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Re: Which Would You Prefer?
Old 02-12-2007, 08:25 PM   #15
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Re: Which Would You Prefer?

I was kinda kidding, but honestly, if my investments popped up 40% in three years I'd get the heck outta there. Maybe buy some CD's...
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Re: Which Would You Prefer?
Old 02-12-2007, 09:04 PM   #16
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Re: Which Would You Prefer?

Quote:
Originally Posted by audreyh1
But chances of the market rebounding 20% in year 5 is really good!
But the market would need a 25% gain to rebound from a 20% loss....
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Re: Which Would You Prefer?
Old 02-12-2007, 09:12 PM   #17
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Re: Which Would You Prefer?

Depending on the definition of total return, Plan A is the better deal for me and most investors.

As other's have mentioned, the total return after 4 years is

Plan A: 15.92%
Plan B: 16.98%

However, a key consideration is the tax liability. My marginal tax rate (federal and state) is 34.7% for ordinary income and interest and 22.9% for capital gains. Assuming that both investments are in taxable accounts and that the return from the equity portfolio is from capital gains (no distributions), if I sell after 4 years my after tax return is

Plan A: 12.27%
Plan B: 10.86%

I'm sticking with the equities in Plan A.

The trick question has a trick answer.

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Re: Which Would You Prefer?
Old 02-12-2007, 09:30 PM   #18
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Re: Which Would You Prefer?

Quote:
Originally Posted by Shawn
Depending on the definition of total return, Plan A is the better deal for me and most investors.

As other's have mentioned, the total return after 4 years is

Plan A: 15.92%
Plan B: 16.98%

However, a key consideration is the tax liability. My marginal tax rate (federal and state) is 34.7% for ordinary income and interest and 22.9% for capital gains. Assuming that both investments are in taxable accounts and that the return from the equity portfolio is from capital gains (no distributions), if I sell after 4 years my after tax return is

Plan A: 12.27%
Plan B: 10.86%

I'm sticking with the equities in Plan A.

The trick question has a trick answer.

Yes, I thought of this also. But did not wish to complicate it, because tax rates vary by individual. But yes the stocks would probably do better after taxes.
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Re: Which Would You Prefer?
Old 02-12-2007, 09:37 PM   #19
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Re: Which Would You Prefer?

Quote:
Originally Posted by wab
But the market would need a 25% gain to rebound from a 20% loss....
Still better than the 4% CD.
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Re: Which Would You Prefer?
Old 02-12-2007, 09:43 PM   #20
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Re: Which Would You Prefer?

Quote:
Originally Posted by Cute Fuzzy Bunny
I'd have sold after year #3.
Given my investment history, I'd have sold the CDs in year 3 and bought equities.
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