Investment update

I thought I'd do a quick investment update. I only own shares in 4 companies right now: AAV, GE, PFE, and JNJ (that's in order of investment size, with AAV being the largest).

AAV has done very well and I have had nice returns both in price and in dividends. With oil so high and natural gas prices heading up for the winter, I'm going to hold this position for the foreseeable future. AAV recently bought another energy company called Sound Energy Trust. This is probably a good move since all of the Canadian Royalty Trusts took a big hit in stock price in the last year (which is why I invested to begin with). So AAV is eating up some of the low hanging fruit, which makes them more valuable in the future.

GE has done better than I imagined, up almost 15%. I wrote before about why I liked GE and some of the issues I talked about have already started to bear out. As the Associated Press notes:

General Electric Co.'s profit rose 14 percent in the third quarter on strong global sales of airplane engines, locomotives and other equipment that have led to a record order backlog.

That's fairly obvious, I guess, but it still is nice to know that I wasn't completely off base. They have over $50 billion in their order backlog, which means they have a pretty safe revenue stream for the next few years. I wonder how big their dividend increase will be this year.

Pfizer has recovered a bit from its low, as I suspected. Recently there have been rumors that Pfizer is going to buy the French company Sanofi, which is the 3rd largest drug company in the world (Pfizer is #1). Well, a lot of people think that's unlikely if only because the French government probably wouldn't allow it. But it seems like Pfizer is definitely looking to buy *something*, which is good since it will give them a future revenue stream once their most profitable drugs lose patent protection. Pfizer currently has about $40 billion in cash just sitting around waiting to be used.

Johnson and Johnson has been rising slowly but steadily. I don't have huge expectations for it since it's a very long term play, and I'm happy so far. One of the silly things I do these days is look out for J&J products at the store. I started using Aveeno shaving cream, which is made by them. When I had to restock on band-aids, I eschewed the store brand for the original BAND-AID brand (by J&J). Every bit counts!

The 401(k) match

I hardly know anything about 401(k) plans because the company I work for doesn't offer them (or any other type of retirement package). But one of the things you hear bantered around the PF world is the "company match." This is typically a scheme where the company will match 50% or 100% of the money you contribute up to a certain total amount of your salary (usually 6% or 3% respectively). People are advised to max out their matched amounts as the first step to retirement savings, followed by an IRA or more unmatched 401(k).

Anyway, what effect does a 50% match have on your savings? It's fairly substantial in the beginning, certainly, but what is the long-term effect? From what I've read, typical 401(k) plans have limited investment choices. Usually you can choose from a mix of mutual funds, perhaps ETFs, and money market funds, but it seems rather limited. Over a 30 year period, how much better do you have to be at investing to overcome the 50% match?

Let's look at how you calculate something like that.

The basic formula for simple compound interest is x = y * (1+z)^t, where t is time, z is your interest rate, y is the initial investment amount, and x is the total at the end.

Well with a 50% match, any y that you invest automatically becomes 1.5 * y. Let's assume that we want x, y, and t to be constant, and we'll see what happens to z. We'll use z for the first interest rate (in the matching 401(k) version) and z' for the second interest rate. Since we're looking for equality, our equation is

1.5 * y * (1+z)^t = y * (1+z')^t

Doing some math...

1.5 * (1+z)^t = (1+z')^t

ln(1.5) + t*ln(1+z) = t * ln(1+z')

z' = e^((ln(1.5) + t*ln(1+z))/t)) - 1

A little complicated. Let's plug in some numbers so we can get a feel for what this equation means. In a short timespan of 2 years (t = 2), if the matched fund returns 10% annually (z = 0.1), our little independent investor would need an annualized return of 34.7% to overcome his disadvantage in not having a match. Over a 10 year period, he would have to achieve 14.5%. Over a 30 year period, he would need 11.5%, a bit easier to achieve.

What does this mean? Well, confirming the obvious, having a company match is a significant advantage in terms of how well your money will grow. However, if you fancy yourself a better than average investor, your 401(k) doesn't provide enough freedom to invest how you like, AND you have a fairly long time horizon, then it may be worthwhile to ignore the company match and make a go of it on your own. As you get closer to retirement age, you would stop your own investments and start taking advantage of the company match. The crossover point could be determined by substituting guessed values for z and z' (based on historical performance perhaps, though remember that's no guarantee of future performance!) and then solving for t.