The 3 key variables in any investing plan

Why You Shouldn't Give Up on Stocks
By Dan Caplinger
January 20, 2010

You'd think that with all the good news investors have gotten lately, all the doomsayers would be laying low. Yet even after the stock market's big rally from last year's lows, some pundits still question whether investing is a hopeless cause.

Keeping your head above water
An article in The Wall Street Journal earlier this week took a close look at the unrealistic expectations that many investors have about the returns they can generate from their portfolios. After a decade during which the broad stock market has laid a big fat goose egg in the return column, a survey showed that investors expect average annual returns of nearly 14% over the next 10 years.

Yet that isn't the most sobering fact about the misconceptions people have about the financial markets. When asked how much they could expect to keep in terms of purchasing power, after accounting for the impact of taxes, investing costs, and inflation, a group of financial advisers estimated a return of between 6% and 9% annually.

Should you hope for returns that are that good? You bet. But should you count on earning them? No way. Fortunately, if you're smart about how you structure your investment plan, you don't have to earn that high a return from your portfolio.

Keep it real
It's easy to understand how people mislead themselves about how much they can earn from investing in stocks. The secret comes down to success stories: We hear the most about winning stocks, while the much larger group of mediocre performers tends to get lost in the shuffle. Take this group of stellar stocks, for instance:

Stock
20-Year Average Annual Return

Dell (Nasdaq: DELL)
32.9%

Oracle (Nasdaq: ORCL)
21.7%

Altria Group (NYSE: MO)
15.4%

United Technologies (NYSE: UTX)
15.2%

Hewlett-Packard (NYSE: HPQ)
14.5%

Source: Yahoo! Finance. As of Jan. 19.

Combine the bull market of the 1990s with the lost decade since 2000, and you'll see that these stocks have greatly outperformed the overall market. Yet when you take away a few percentage points for inflation, a few more for taxes, and another point or so for trading costs, you'll notice that only the best performers manage to stay in double-digit territory.

More importantly, recall that these are the big winners. For every stock like this, there are several like Dow Chemical (NYSE: DOW) and Citigroup (NYSE: C) that have languished with much smaller gains -- and others, such as General Motors, that have contributed substantial losses to the overall picture.

Stay on target
But don't let the sobering reality of the investing world convince you that it's impossible to reach your financial goals. There are three key variables in any investing plan:

• how much you can save,
• how much you earn on your investments, and
• how much you need to spend.

Investors tend to focus almost solely on their portfolios' earning potential and think a lot less about the other keys to financial success.

If you're not making the most of your financial situation to save as much as you can, then you're making a huge mistake with your money. By saving less than you could afford to save, you'll take bigger risks than you need to. Sometimes, those risks will go sour, costing you what would have been an easily attainable financial goal. Just as millions of investors learned too late that their portfolios included more high-risk investments than they really needed, you could be making big bets that you don't need to make in order to have a safe, secure retirement.

You'll get there
What you do need to do, though, is have realistic expectations. If you're more conservative about the return assumptions you make, you'll have to find more savings to reach a certain target value for your portfolio. But you'll also have more options to help you get there, rather than relying on finding tomorrow's top performers at all cost.

If you can do that, then you won't be fooling yourself about your investing. As hard as it is to rein in expectations during a roaring rally, doing so will leave you in a better condition to make rational decisions about your portfolio -- decisions that are likely to lead to exactly the returns you need to reach your goals.

Many people are nervous about 2010's prospects.

http://www.fool.com/retirement/general/2010/01/20/why-you-shouldnt-give-up-on-stocks.aspx