| I've been receiving
a lot of questions and I want to thank everyone who has sent them in. This week
I'm going to answer two that have been forwarded from the home office in Escanaba,
Michigan
Question: What will be the catalyst to propel value stocks in the year 2000?
First let's define our terms. Value stocks traditionally include older, established
industrial companies,
while growth stocks typically include younger firms such as high-tech and Internet
companies. Value
stock investors typically rely on company fundamentals (such as earnings, revenues and
assets) to
help them decide what to buy or sell, while growth stock investors have focused more on
earnings
potential.
Growth stocks, led by the Internet boom, have risen considerably over the last five years
even
though value stocks have been selling at low prices relative to earnings (which should
make them a
bargain-hunter's dream).
The reason value stocks will do well this year is that fundamentals are becoming more
important to
stock valuation that simply the idea of future potential opportunities.
What we're seeing now is that the price differential between value and growth stocks is so
great that
value stock prices are lower than their fundamentals indicate they should be. At the same
time,
earnings and revenue (i.e. fundamentals) are becoming relatively more important to growth
stocks
compared with just the idea of future potential opportunities.
This is better for value stocks relative to growth stocks. Long-term history bears that
out. The last
five years don't bear that out, but we're not investing five years ago. We're investing
today.
Say you buy a stock with a price-to-earnings (P/E) ratio of 150 versus a stock that has a
P/E ratio
of 15. The 150 P/E ratio has to keep climbing to justify the stock's valuation while the
stock with the
P/E ratio of 15 remains stable at 15.
If you think those ratios are spread too far apart and the 15 stock should really be 20,
and the 150
should really be 80, you're still saying that the growth stock is worth more than the
value stock
compared to earnings. But you are also saying you would really rather buy the value stock.
Question: I am looking for some statistics for a retirement 401(k) enrollment meeting. I
want something that will "startle" the participants into action. I've looked
everywhere and
can't seem to find what I am looking for. What would you suggest?
I would suggest giving them a concrete example to show the value of compounding, and how
that
value is increased when you save in a tax-deferred account like a 401(k).
Here's a very basic example just to illustrate the point.
Suppose you're 25 and invest $1,000 today. At a 10% rate of return and a 30% tax rate,
with no
further contributions, in 40 years that $1,000 will grow to $14,974.
That's not too bad, but you can do better.
Assume the same investment conditions, but your investment is in a 401(k) plan, where you
don't
have to pay taxes on the interest you earn each year. If you invest $1,000 and leave it
for 40 years
under those conditions, the final result is $45,259. (Of course, you'd have to pay tax on
this amount
when you withdraw it, but you'd still be left with roughly $31,000, at a 30% tax rate.) As
you can
see, deferring taxes can save a big chunk of your final return.
Now, let's assume you have a generous employer and receive a 50% matching contribution.
So,
you're investing $1,000 of your own money, the company kicks in an extra $500 and it's a
tax-free
investment over 40 years. Here's the number that should knock your audience's socks off --
at the
end of 40 years, you'll have $67,889. (After 30% taxes, about $48,000.)
It's always smart to invest your money. It's even smarter to invest your money where you
get the
company match and you invest at a tax-deferred rate. You always end up with a higher final
number. That's the power of compounding!
 Lummer's Logic Archives
Scott L. Lummer, Ph.D., CFA, 401k Forum's Chief Investment
Officer, is a recognized expert in the investment field. He has conducted extensive
research on asset allocation, international investing, risk management, mutual fund
analysis, ethics and valuation, and is a co-author of The Pension Investment Handbook.
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