The stock market has recovered, but have you?
The financial media world is all abuzz with U.S. stocks — as measured by the Standard & Poor's 500 — surpassing where they were in October of 2007, right before the Great Recession and a more-than-50 percent plunge.
It took more than five years, but better that than never. Pity the poor investors who invested in the Nikkei 225 (the main index of Japanese stocks) at its 1989 peak. It's still down almost 70 percent, even though Japan was the globe's second-biggest economy through most of that period (until being surpassed by China a few years ago).
So you might think that if you invested $100,000 in the S&P 500 back in October 2007 — perhaps by owning shares of the Vanguard 500, an index fund that attempts to match the performance of the S&P 500 (and a fund I own) — you'd have just $100,000 now. Your investment grew zilch. But it's probably not quite that bad, because market indexes just measure the change in the prices of stocks and not the dividends they pay. A dividend is a share of a company's profits that is paid to its owners. And remember: When you own a share of a company's stock, you are a genuine, honest-to-goodness part-owner of the company.
Most of the companies in the S&P 500 pay dividends (the other companies keep the money to reinvest in the business to make it more valuable). And most investors use those dividends to buy more shares, which leads to more dividends, which can lead to more shares. For investors in the Vanguard 500 who have reinvested dividends since Sept. 30 2007, their $100,000 investment would now be worth almost $115,526, according to Vanguard. Not an impressive return to earn over five-and-a-half years, to be sure, but it's better than nothing.
But Wait — There's More!
Ideally, dividends weren't the only way investors were buying more shares. Those who were continued to contribute to their 401(k)s and IRAs were purchasing more shares as they declined and then rebounded. Assuming an initial investment of $100,000 and monthly contributions of $500, an investment in the Vanguard 500 would now be worth $161,348.
Of course, this is all predicated on being able to keep saving during the recession. Unfortunately, many people couldn't, due to job loss or other financial difficulties. Also, plenty of companies suspended the 401(k) match, which means many people weren't able to take full advantage of the drop in stock prices.
Also, retirees were in the opposition situation — having to withdraw money as the market sank, rather than buy more shares. This is why we Fools recommend that retirees have an “income cushion” of five years' worth of expenses they expect to come from their portfolios out of the stock market and in cash or short-term bonds. This keeps the money you needed in the next five years safe, while the retiree waits out a bear market.
You're Not an Index
So while following the ups and downs of a market index can be worth keeping an eye on, it's only one piece of your personal puzzle. Whether you bought, held, or sold has just as much impact on your current net worth as well as what type of investments you owned. The metric you should be regularly monitoring is the “Will I Meet My Financial Goals” Index, a very personalized and fluid calculation that factors in how much you have, how much you're saving, and then matches that up with what you need and when.