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Beware the New Math and Your 401K

by Ouida on April 1, 2010


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I’m tired of reading in the financial press that my 401K is recovering. I have only to look my the statement to know the lie of it. But then maybe if I apply the New Math it really has recovered and is on its way up.

New Math was conceptual mathematics popularized in the United States after the Soviet launch of Sputnik. After a decade, it was widely considered a failure. Teachers were afraid to teach it and parents were afraid they wouldn’t be able to help their children with their homework.

A humorous illustration of New Math can be found at
http://www.straightdope.com/columns/read/1529/what-exactly-was-the-new-math

The following examples may help to clarify the difference between the new and old math.
1960: A logger sells a truckload of lumber for $100. His cost of production is 4/5 of this price. What is his profit?

1970 (Traditional math): A logger sells a truckload of lumber for $100. His cost of production is $80. What is his profit?

1975 (New Math): A logger exchanges a set L of lumber for a set M of money. The cardinality of set M is 100 and each element is worth $1.

(a) make 100 dots representing the elements of the set M

(b) The set C representing costs of production contains 20 fewer points than set M. Represent the set C as a subset of the set M.

(c) What is the cardinality of the set P of profits?

1990 (Dumbed-down math): A logger sells a truckload of lumber for $100. His cost of production is $80 and his profit is $20. Underline the number 20.

1997 (Whole Math): By cutting down a forest full of beautiful trees, a logger makes $20.

(a) What do you think of this way of making money?

(b) How did the forest birds and squirrels feel?

(c) Draw a picture of the forest as you’d like it to look.

Popular financial wisdom tells us that because the Dow is up 67% as of today from its 2009 nadir that we should cheer up, our finances are on the mend and the 401K is still a great long term financial strategy. But I keep remembering a troublesome concept taught by William O’Neil, entrepreneur, owner of Investor’s Business Daily and author of How to Make Money in Stocks and 24 Essential Lessons for Investment Success.  If the markets tank 50% how much of a gain is required to get back to baseline? 100%.

Now here is some real math: You invest a dollar and lose half of it. You now have 50 cents. You would have to double your money or get a 100% return to get back to 1 dollar. From its October 9th peak in 2007 of 14,164.53 to its trough of 6547 on March 9th, 2009, the Dow shed 54%. To get back to even, the Dow would have to gain 104%. In other words for you and me to break even and get back to where we were in 2007 at the market peak, the Dow would have to gain 104%. Historical tables show that the S&P lost 36% in 2008. To get back to zero, the S&P would have to gain 72%. The S&P gained 19.7% in 2009. New contributions, even if there is an employee match, are not a legitimate part of our overall investment return. Investment returns are based on the growth of a dollar over time, not the growth of a dollar because you added another dollar to it. In looking at my statement, my 401K is now worth just over what it was at its 2007 peak. That is if I include my ongoing contributions and employer match in the mix. If I don’t and I shouldn’t I am still down 12.2% fortunately I am not exclusively in stocks so the losses were mitigated. Only new math would allow me to think I am on track and can build a secure retirement with returns like that.
Amazing! Fortunately I have investments outside of the market, investments I have greater control over to ensure my retirement.

What is your belief in the stock market as a retirement vehicle?  Please comment.

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