I really like the example of two paths to the same summit of $500,000 in savings:

Path 1. Rely more on the stock market with a larger allocation to stocks and $5,000/year savings

Path 2. Rely less on the market with a smaller allocation to stocks and increasing your savings of $5,000/year by 10% each year.

Path 1 is an ordinary annuity problem. Path 2 is a growing ordinary annuity problem. Verification of these numbers will make an excellent extra credit assignment for my students… 🙂 (solution available on my OneDrive).

Nevertheless, I highly recommend reading this article for perspective on investing in today’s environment. I also like how the article validates what I frequently say in class: the long run average P/E for stocks is 16.5. The average of VTI is 18.1 (http://money.cnn.com/quote/etf/etf.html?symb=VTI). A little high but better than the 25 number mentioned in the article. So, be mindful of P/E.

Enjoy the article…

http://m.us.wsj.com/articles/SB10001424052702304732804579423350714558572?mg=reno64-wsj

Lessons From the Bull Market

Do you remember how you felt about the stock market on March 9, 2009?

Evidence suggests many investors have blocked out those fearful times. Five years after the S&P 500 hit its lowest point during the financial crisis, investors are pouring money into stocks.

In 2013, investors put $172 billion into U.S. stock mutual funds and exchange-traded funds, more than they had withdrawn from 2008 to 2012 combined, according to Lipper, which tracks funds. They have added another $24 billion in 2014, through Wednesday.

A little complacency is understandable. If you took a Rip Van Winkle nap starting in 2007 and woke up this weekend, you might conclude nothing bad had happened. The S&P 500 has shot up to record levels and hit another all-time peak on Friday. The index is up 178% over the past five years, not including dividends.

If you stuck with stocks throughout, your reward would be huge: An investor who wagered $100,000 on the index on March 9, 2009, would have $308,127, including dividends, as of Wednesday, according to Chicago-based investment-research firm Morningstar.

But the financial crisis was real, and so was the steep plunge it triggered in the stock market. “People watched their money get cut in half, if not more,” says Peter Tuchman, a floor broker at the New York Stock Exchange for Quattro M. Securities. “That was such a wake-up call.”

Instead of sweeping those memories aside, investors need to reflect honestly about what that bear market meant, how it affected their behavior then and how it ought to factor into their thinking now.

Above all, investors would be wise to avoid betting on anything that looks like a prediction. Instead, they should prepare for the future with a few strategies whose enduring value has been underscored by the events of the past five years.

Be Skeptical of Experts

Every day, in the newspapers, on financial-news shows and online, dozens of market strategists make bold predictions about the direction stocks are heading.

Take their forecasts with a mound of salt.

After all, current prices already reflect the sum of stock-market buyers’ and sellers’ opinions. If one investor is bullish, there must be another investor on the other side at the current price, notes Philip Tetlock, a professor of management at the University of Pennsylvania’s Wharton School.

Forecasts get better as more experts’ opinions are brought in, says Mr. Tetlock, who is currently running a forecasting tournament in which anyone can participate at GoodJudgmentProject.com.

In a March 2, 2009, Wall Street Journal article, for example, Wilmington, Del.-based financial adviser Judith Lau said that for many months she had built up clients’ allocations to bonds and cash and that she thought it could take 18 months or longer for stocks to pick up again. In fact, stocks would be up sharply by the end of 2009.

She wasn’t alone, of course. The Journal in early 2009 quoted more than a dozen strategists, financial planners and money managers who said they expected things to get worse before they got better.

“In hindsight, we would have put everything we had in the market on March 2 and told our clients to hang on. We would have lost a third of them, but they would have made a gazillion dollars and would have been happy,” Ms. Lau, whose firm oversees about $600 million, says now. “But you don’t have the benefit of hindsight.”

The lesson: Take expert predictions lightly, and if you act on them, make small moves rather than drastic ones. Even though she thought stocks would continue to suffer, Ms. Lau in the 2009 article recommended a portfolio that was half in stocks.

And a corollary: An expert who was once “right” won’t necessarily be correct again the next time. In choosing which experts to listen to, pick ones who seem aware of the uncertainty of their predictions and are willing to change their minds, says Prof. Tetlock.

Remember What Losing Felt Like

In a speech about intellectual honesty 40 years ago, Nobel Prize-winning physicist Richard Feynman said, “The first principle is that you must not fool yourself—and you are the easiest person to fool.”

Many investors appear to be kidding themselves. Financial advisers report that some clients appear to be forgetting the intense fear they felt five years ago.

With U.S. stocks up more than 32% last year, many are asking why their personal accounts were up less than 20%.

In 2009, the pain of further losses on stocks was too great for some investors to bear; now, it is the pain of not holding more stocks that bothers them. “Memory has done a kind of 180-degree turn for some people,” says Owen Murray, a partner at Horizon Advisors, a financial-planning and investment-management firm in Houston that oversees about $230 million.

Some clients are asking, “Why haven’t we been more aggressive?” even though they were the ones who insisted on making their portfolios more conservative in the wake of the crisis, says Daniel Roe, chief investment officer at Budros, Ruhlin & Roe, a financial adviser in Columbus, Ohio, which manages about $1.7 billion.

What they should be asking is this: Am I fooling myself into remembering my losses as less painful than they were? Am I itching to take risks that my own history should warn me I will end up regretting? Am I counting on willpower alone to enable me to stay invested and to rebalance through another crash?

For the answers, dig up your old account statements to see whether you held fast in late 2008 and early 2009. Ask your spouse or a close friend how anxious or afraid you were during the crisis. Then ask yourself whether you want to repeat that experience.

If your records show that you bought or stayed put during the last crisis, then you can probably weather the next one—and should stay put now. But if you sold then, you almost certainly will sell again if the markets take another steep fall. In that case, you should consider using the recent market gains as a gift that enables you to take some risk off the table before it can hurt you again.

Limit Your Risk-Taking

Owning some stock is a good thing for many investors. Over long periods, stocks tend to outperform bonds by a few percentage points annually, giving a powerful boost to portfolios. Investors who dumped their stocks have missed out on that benefit over the past few years.

Instead of periodically bailing on stocks, investors would be better off keeping a smaller amount in stocks and sticking with that allocation in good times and bad, says David Allison, a vice president at Allison Investment Management in Wrightsville Beach, N.C., which oversees about $70 million.

Alternatively, investors can pare back their stock allocation if they’re willing to step up their savings rate to compensate, says Chris Philips, a senior analyst at Vanguard Group.

Take an investor who starts contributing $5,000 a year to a brokerage account. If he put his entire portfolio in stocks, and stocks went on to return 8% annually, he would have $500,000 after about 26 years, according to an analysis by Mr. Philips.

If the same investor drastically cut his stock allocation, reducing his expected return to 4%—but increased his retirement-account contribution by 10% every year to compensate—he would hit $500,000 after only 22 years.

“You don’t have to rely so much on the market to get you where you want, but if you want to rely less, you have to be willing to increase those savings,” he says.

Be Wary of Labels

Investors who hear the phrase “bull market” might decide it is time to get in on the rally. On the other hand, investors who hear the current bull market in stocks has been running for five years might worry it will soon end. In either case, investors would do better to tune out the chatter. The definition of a bull market is arbitrary, and the term tells investors little about what will happen next.

The Wall Street Journal and many other market watchers call it a bull market when stocks rise 20% off a low point, and a bear market when they fall 20% from a peak. But investors who use slightly lower thresholds would see a more volatile picture of how stocks have behaved in recent years.

Plug in 15%, for instance, and suddenly there have been two bear markets since March 9, 2009, according to data from FactSet. Even using 19% would result in a bull market that lasted until April 29, 2011, followed by a bear market that endured for more than five months, and then the current bull market.

In fact, that 2011 drop almost qualified as a bear market under the widely accepted definition. Stocks fell early in the trading day on Oct. 4, 2011, and at one point the S&P 500 was down 21% from its April peak. But stocks rallied that afternoon, and the narrative of a five-year bull market survived.

The small sample size is another issue. There have been only 11 bull markets—using 20% as the yardstick—since the start of 1957, the year the S&P 500 was introduced in its current form, according to FactSet. Using past data to try to gauge how long a bull market will last is tricky because of the huge range—the longest one since 1957 lasted 3,109 trading days, the shortest just 30.

Taking an average could just exacerbate the problem. “That’s where a lot of people go wrong,” says Laszlo Birinyi, president of Birinyi Associates, an investment-research firm in Westport, Conn. “There is no such thing as an average bull market.”

Investors would be better off focusing on whether stocks are valued more highly than in the past. By that standard, stocks warrant more caution today than five years ago.

In March 2009, stocks traded at about 13 times their average earnings over the prior 10 years, adjusted for inflation, according to Nobel Prize-winning economist Robert Shiller of Yale University. Now, stocks are trading at about 25 times average earnings. The historical average is 16.5.

Terms like bull market and bear market are eye-catching labels—not forecasts.

Question Performance Figures

It is one of the most oft-repeated adages in investing: Past performance doesn’t guarantee future results. In fact, it can be a poor guide to past results, too.

Many mutual funds and investment advisers promote themselves based on their average annual performance over the prior five years. As of the end of February, their returns suddenly looked a lot better—not because the managers have gotten smarter or cut fees, but because of luck.

That’s because the five-year period now begins in March 2009—a month in which U.S. stocks returned 9% as the financial crisis began to wane. By contrast, stocks lost nearly 11% in February 2009; that bloodbath has just dropped out of the five-year return sequence.

According to Morningstar, the five-year average annual returns of more than 40 mutual funds improved by at least seven percentage points when the pages of the calendar flipped from February to March.

Real-estate funds were the most common beneficiaries, with their long-term returns shooting up largely due to the disappearance of a single month. On March 1, the five-year average annual return for the Franklin Real Estate Securities Fund went to 26.8% from 19.7%; for the Columbia Real Estate Equity Fund, to 26% from 19.4%; for the Fidelity Real Estate Investment Portfolio, to 30.8% from 23.1%.

In February 2009, real-estate investment trusts lost 20.8%, as measured by the FTSE NAREIT All Equity REITs index.

February 2009 has just been replaced by March 2009, when REITs gained 4.1%. So the five-year returns on real-estate stocks have gotten a huge boost that might make them sound almost irresistible.

REITs can be useful in diversifying the risks of stocks and bonds. But they are risky, too. The many financial advisers touting REITs as “bond alternatives” have no incentive to call attention to the carnage of February 2009. But that 20.8% loss wasn’t imaginary.

If the past is any guide, financial advisers will tout the suddenly higher returns of their funds, and money will pile in. Research by finance professor Raghavendra Rau of the University of Cambridge and his colleagues has shown that investors flock to funds whose five-year returns improve when a bad month drops out of the beginning of the sequence.

Fund companies, according to the research, advertise more and even raise their fees to take advantage of the “improved” performance.

Whenever anyone tells you about an investment’s five-year returns, remember to ask what those returns looked like at the end of 2013—or, even better, in March 2009. They might suddenly sound a lot less appealing.

Write to Jason Zweig at intelligentinvestor, Joe Light at joe.light and Liam Pleven at liam.pleven