An inheritance gone awry

Would you be happy receiving an inheritance? Sure you would. What if, nearly 50 years later, you discovered that the inheritance was invested poorly and the results were subpar; so much so that you could have easily had one million dollars instead of $60,000. Would you still be happy about your windfall?

Recently, a retired widow – let’s call her Agatha – informed me that a few decades earlier, she received an inheritance from the parents of her deceased husband. The money was invested in a stock mutual fund in 1970 and neither Agatha nor her in-laws have ever touched it since. She was a little embarrassed when she indicated that she hadn’t ever touched the money; indicating that she never altered the investment in any way. She just “let it ride.” After some forty-seven years’ worth of compounding, she simply wanted to know if the money was invested wisely or otherwise.

Not wanting to pry, I didn’t ask Agatha how much money was in the fund. Instead, I asked her how much the value of the investment has grown over all those years. She said that the assets have appreciated six times from inception until today. To make sure we were saying the same thing, I suggested that (for example) if her in-laws invested $10,000 back in 1970, the mutual fund was now worth $60,000. She said, “Yes, that’s exactly right.”

Calculating the returns

I opened up a calculator to determine what her compounded annual gains were. This calculator uses just three inputs: Present Value, Future Value, and Years. Enter that data, and then press “Calculate” to see what the compounded annual growth rate (CAGR) has been. In this instance, the CAGR was 3.89%. When I saw that figure, my heart sank a bit. I instinctively knew this return on this investment was really subpar. I immediately knew, without hesitation, that Agatha’s investments would have done much better had the money been invested in an S&P 500 index fund. To confirm this, I checked the historical return of the S&P since 1970.

There are several websites which can provide this information. One that I like is from, short for “Don’t Quit Your Day Job.” The folks at DQYDJ have a nice tool which allows you to not only see historic returns for the S&P 500 dating back to 1871, but you can see it in today’s dollars, and you can either include or exclude dividends as part of your return. Select any month between January 1871 and the most recently ended month to see what the returns were.

What a difference 3% a year can be

Over the past 47 years or so (from 1970 through now) the S&P 500 has had a compounded annual return of 7.17%, that’s well over three percent more than the 3.89% that Agatha’s investments earned for her. Agatha’s reaction was “Well, that’s just three percent (difference), that’s not bad.” I explained that the three percent annual difference was huge. I told her that instead of a 6X return on her money, I suggested offhandedly that the return from the S&P 500 would have been more like 10X or 11X.

This was somewhat sobering to Agatha, but she resigned herself to the fact that she never needed the money and likely never will; it will just end up as part of her children’s inheritance. The variance between Agatha’s mutual fund’s return and the S&P 500’s return is actually much more than what a three-plus percentage points disparity might suggest.

Compounding: The 8th wonder of the world

Compounding is the eighth wonder of the world; a quote attributable to Albert Einstein. As I’ve mentioned many times in the past, your investments grow exponentially and when invested over long periods of time, say decades, the gains can be incredible.

Late last year, as the Chicago Cubs were winning the World Series for the first time in over 100 years, I wrote about the magic of compounding; how much money you could have made over those 100+ years had you invested that $1.50 – that was the cost of a ticket to see a World Series game that year – in an S&P 500 index fund.

The results were, to say the least, impressive. Think about a snowball. Initially, the snowball fits in your hand. As you roll it through the snow, more and more snow accumulates. The ball gets bigger and bigger. The same idea applies to your assets over time as well. As the years go, your money grows dramatically.

A 3% variance over many years is what separates a master investor from an index fund investor

Agatha’s sub 4% return over nearly a half-century netted her a six-fold return on her money, increasing her family’s initial investment of $10,000 to $60,000. I was really understating the difference between her return and the S&P 500’s return over that time. A three percent annual difference really “snowballs” after 47 years.  A three percent variance over many years is what separates a master investor from an index fund investor, and over time can really add up to a fortune.

$10,000 becomes $259,000

I mentioned to Agatha that the S&P 500’s return of a bit north of 7% was worth about twice what her return was. In actuality, a $10,000 initial investment in an S&P 500 index fund in 1970 would have grown to be worth more than $259,000 today. That’s almost four times as much as her money had grown. And, the difference gets even more dramatic.

Dividends matter, a lot

It’s quite likely that the returns on Agatha’s mutual fund included the reinvestment of dividends. It’s common for mutual funds to allow investors to reinvest their dividends, and typically investors opt for this approach rather than having the cash distributed. After all, the dividend payout in-and-of-itself is usually relatively small, but again, through the magic of compounding, it really adds up.

$10,000 becomes $1,000,000

The 7.17% annual return for the S&P 500 over the past 47 years is exclusive of dividends. Had you elected to reinvest all of the dividends collected from the S&P 500 over all those years, the compounded annual return would have been 10.36%, almost tripling the mutual fund’s rate of return. That $10,000 initial investment could have been worth a little more than one million dollars. Imagine receiving an inheritance of $60,000 which could have easily been worth more than a million dollars if it had been invested in an index fund. It’s pretty sobering if you ask me.

Actively managed funds underperform

The return of less than four percent for the mutual fund over 47 years is really appalling. It’s well documented that more than 80% of mutual funds underperform their associated index fund. A report by indicated that almost all U.S., global, and emerging market funds – a full 99% percent of them – have failed to beat their benchmarks since 2006. There are many reasons why funds underperform. One of the reasons is fees. Actively managed mutual funds frequently charge much higher fees than passively managed index funds.

While the variance in expenses between those two types of funds is considerable today, it’s much lower today than it once was. In the 1970s, mutual fund companies came under criticism for the high front-end sales loads they charged along with excessive fees and other hidden charges. As a result, they introduced multiple share classes giving investors several options for paying sales charges. All of these fees served to dampen the returns relative to their benchmarks.

The performance of the mutual fund that Agatha’s family was invested in was disastrous. To be fair, however, in 1970, Agatha’s family couldn’t have invested their money into an index mutual fund. Today, we take index funds for granted, but such funds didn’t exist in 1970. The first such fund was offered by The Vanguard Group in 1975.

Regardless, it’s not as though the problem couldn’t have been rectified. Anytime from 1975 onward, that money could have been moved from the actively managed mutual fund into a passively managed stock index fund. Unfortunately for Agatha, the money wasn’t transferred out. The fund that Agatha’s money was invested in performed poorly; really, really poorly. It may not have performed much worse than comparable funds, it’s difficult to compare. Throughout history, when some mutual funds have performed poorly, the fund family has closed those funds and started new, relatively comparable funds. Warren Buffett has frequently spoken poorly of the mutual fund industry.

What about bonds?

Stock mutual funds aside, let’s compare the fund’s returns against other investment options. It’s not uncommon for mutual funds to underperform their benchmarks. As we know, most stock-based mutual funds frequently underperform their associated benchmarks. While that may be the case, you would expect stock funds to beat bonds. Historically, stocks beat bonds. Unfortunately, for Agatha, that wasn’t the case in this circumstance. An investment in 10-year U.S. Treasuries would have returned a very respectable 7.28%; far exceeding Agatha’s mutual fund’s return. The treasuries even eked out a slight advantage over the S&P 500 index, if you were to exclude dividends.

10-Year U.S. Treasuries:

Why did bonds do so well? Those who have only been investing for a few years might think that bonds return next to nothing. That’s certainly been the case recently. Currently, the 10-year is paying about 2.33%. Last year at this time, the 10-year was paying a paltry 1.75%. But, back in the 1970s and 1980s, inflation was rampant. Bonds were paying high single-digits throughout the 1970s and double-digit rates in the early 1980s. So even with the low single-digit interest environment that we’ve experienced all through this century, an investment in the 10-year U.S. Bond over the past 47 years would have outperformed the mutual fund that Agatha was invested in.

Cash is king

A high-interest rate environment also meant that CDs were paying reasonable returns. Even if you invested all of your money in CDs, you would have outperformed Agatha’s mutual fund. A portfolio consisting solely of CDs since 1970 would have returned 4.76%, that’s a full percentage point more than the stock mutual fund.As we know, the magic of compounding comes into play so that extra one percent average return, compounded each year would have turned that $10,000 into almost $89,000. This mutual fund underperformed most other investment options. With the high front-end sales loads they charged along with excessive fees and other hidden charges, you could argue that this mutual fund robbed Agatha.

As we know, the magic of compounding comes into play so that extra one percent average return, compounded each year would have turned that $10,000 into almost $89,000. This mutual fund underperformed most other investment options. With the high front-end sales loads they charged along with excessive fees and other hidden charges, you could argue that this mutual fund robbed Agatha.


I didn’t mention this to Agatha. There’s no reason to make her feel badly about her investment results. Coincidentally, however, she did mention that she once had a financial advisor who embezzled $50,000 from her and her late husband’s nest egg. These were people of modest means. A $50,000 hit, while significant in anyone’s books, was enormous to Agatha and her husband. She shrugged it off though.

Adding insult to injury, she and her husband never felt that they needed a financial advisor and other than the person who stole $50K from them, they always managed their own money. Here’s the kicker, she knew the advisor personally! This financial advisor was the spouse of Agatha’s husband’s co-worker.  The good news is that the advisor served time in prison. The bad news is, he’s out now and Agatha never got the money back. (It should be noted that this behavior among financial advisors is rare.)

What to do

If you are investing your money, you should be investing in a low-cost index fund. Most financial advisors suggest that you keep a portion of your money in a stock index fund; a portion in a bond fund; and maybe a portion in an international stock fund. That’s it. Two or three funds, with the assets allocated based on your age. The older you are, they more money you should have in bonds. Conversely, the younger you are, the more you should have in stocks.

Asset allocation

Most advisors suggest 110 minus your age should be your stock allocation. So a 40-year old would have 70 percent in stocks (either the S&P 500 index fund alone or divided between that fund and an international fund) and the remaining 30 percent in bonds. A 55-year old would have 55 percent in stocks and 45 percent in bonds, etc.

Alternatively, you could follow Warren Buffett’s approach. Upon his demise, he plans to leave his wife with 90 percent of her money in an S&P 500 index fund and the remaining 10 percent in cash.

Start early

Regardless of how you choose to invest your money, start as early as you can and invest as much as you can. Money snowballs over time. The earlier you start, the more you will have. If you start Investing $10,000 every year when you are 25 in the S&P 500, you will likely have over $3 million when you reach your retirement age of 67 years old. (That assumes just an 8% return, less than historic returns.) If you wait just ten more years and start investing $10,000 a year when you are 35, you would only have $1.3 million. Money snowballs. Start building your snowball as soon as you can.


Image credit: Brl and Flickr

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