Hopefully this will be the last time we need to resort to financing, although you can’t beat 0%. It irritates me when we’re cruising along financially and all of a sudden here comes a large bill we need to pay for something we bought in the past. Generally I think we’ve been pretty smart when using financing, but I still don’t like it. At least some of the money we spent on the closet went toward increasing the value of the house. And the computer is the single most crucial tool used in our house. My wife uses it to work and we use it to track our finances.

At least I know I’m getting ESPP money in a couple of months and I’ll be able to pay it off. The stock purchase plan is a guaranteed 15% return in 6 months and it’s pretty much impossible to beat. If my company’s stock would ever go up I’d make even more than 15%, but in this environment I’m pretty happy with everything I get.

It’s relatively safe to say that, given enough time, future stock values should be higher than they are today. How much is enough time? Nobody knows. Are stocks likely to be worth more in 8 years than next week? Probably, but the Dow was at 10834 on November 9, 2000 - resulting in a loss in the stock market over the past 8 years. Investors in 2000 relying on a repeat of the past have lost money in the past 8 years.

If we look at rolling 30 year periods in the stock market stocks have never lost money. Thirty years also corresponds fairly well to a working lifetime for most Americans. So, given what’s happened in the past, we can be fairly certain that stock values will be higher in 30 years than they are today. In fact, if we look at stock market returns over 10 year periods we don’t see any losses. Holding stocks for 10 years has always resulted in a positive return, historically.

Fantastic, but are stocks likely to return the 10%+ annually that they have over the past eight decades? I, for one, don’t think so. Most so-called experts agree, counseling investors to use 8% as the expected annual return of stocks in the future. Is 8% accurate? It’s lower than what we’ve seen in the past. But none other than Warren Buffett thinks 8% is too high. In an article in Fortune in 1999, Buffett gave a lesson on how to estimate future stock market returns with a simple formula:

Expected real GDP Growth + Expected Inflation + Expected Dividend Yield

If we look at Buffett’s formula and compare that to actual values from history, stocks have actually underperformed the formula most of the time. And if we plug numbers from today into the formula we’re looking at 6.5% annual returns - before expenses and fees (and taxes).

It’s no secret U.S. GDP growth is flattening. The United States is moving from an industrial, manufacturing economy to a services-based economy. This makes measuring GDP more difficult and results in lower numbers. GDP is defined as the total market value of all final goods and services produced within a country. Putting a price on services in considerably more difficult than putting a price on goods.

It’s been said that consumer spending accounts for about 70% of the U.S. economy. Consumer spending has been on a downtrend of late, with retail predictions for the coming holiday season dismal. A decrease in consumer spending will equate to a decrease in GDP, since companies that produce products will see a decrease in the number of those products sold.

Another factor pointing toward lower future returns is the maturity of the U.S. economy. During the 1900’s the United States was an emerging market. The country wasn’t very old at the beginning of the 20th century and the industrial revolution was just getting going. New industries were coming online and for most of the 1900’s the economy went on a rapid expansion, sending stock values soaring. The last 20 years of the 20th century were especially dynamic, with U.S. stock markets in a generation-long bull market. With the U.S. moving into a more mature economy, growth prospects for the next century aren’t as great. Many of Europe’s oldest economy’s have experienced the same maturity cycle, with corresponding lower stock market returns.

So what can we expect for returns in the future and what do we do about it? Using Buffett’s formula above, it seems like 6% is about the best we can hope for. This is not much higher than the historical return on bonds, which is about 5.2% - with considerably less risk. With interest rates currently very low, bonds are likely to have higher yields, and higher returns, going forward. Benjamin Graham, the father of value investing, advocates a portfolio of 50% bonds and 50% stocks in his investing classic The Intelligent Investor. This seems like a solid plan for the future if stocks market returns aren’t destined to outpace bond returns.

Of course nobody knows what the future holds. With stocks badly beaten down in the current bear market, it’s quite possible that stock market returns in the next few years will be higher than 6%. It’s equally possible that returns will be flat or negative. For my part I plan to explore stocks with a solid history of dividend payments. Dividends have accounted for a large chunk of the gains seen in the stock market historically. Concentrating on maximizing dividends seems like a solid strategy that should pay off in any type of market. I also plan to learn more about bonds and I will likely follow Ben Graham’s asset allocation advice.

Luckily I had the conviction to unwind my ultrashort position in DXD for a decent gain in only a few days. I think the market will move back up for a bit and then drop back down below the low point from 10/10. For now I’ve got my long positions in place and I plan to move out of those and into more ultrashorts when it’s time.

With impeccable timing yesterday afternoon (OK, luck), I sold some more long holdings and bought more DXD. I now have enough DXD that I’m no longer just hedging my long positions. I am actively making money as the markets continue their freefall. I still have long positions because I don’t when things are going to turn around, but I’m fairly sure things will turn around at some point.

For the foreseeable future I will be keeping a close eye on all things financial. We’re cutting all unnecessary spending down as low as possible. Luckily we don’t have anything big planned in the next few weeks. Our regular monthly expenses are already as low as we can stand them at the moment, there’s really nothing else to eliminate. I’m just glad I’ve got some time before I can touch any of the money I’ve got invested. It’s sure beginning to look like it’s going to take a long time for things to recover. Hopefully we’ll be back on to a massive boom once again when we have everything shaken out.

There are plenty of opportunities to make money even while the market is declining. An options trader can buy puts, which is a bet the underlying security to the put will go down. Puts are available on individual stocks as well as indexes and ETFs. If you’re not into options you can buy a “short” ETF. This is an exchange traded fund that increases in value while it’s underlying index decreases in value. Short ETFs are available for most any index that has an ETF. In addition to short ETFs there are “ultrashort” ETFs, which try to go up twice as far as the index goes down. For example, if the Dow Jones Industrial Average Drops 1%, the Dow Ultrashort ETF should go up 2%. For higher capitalized traders there are hedge funds and futures as well.

Because my Rollover IRA can be traded pretty much however I see fit, I’ve made a change in my holdings. I sold half my S&P 500 index ETF and bought an equivalent amount of DXD, which is an ultrashort Dow ETF. This isn’t enough to make me a bunch of money as the Dow continues to fall, but it hedges the losses and leaves me primed to take advantage of any upside moves. I’ll sell this once I think the downtrend is over.

In my 401(k) I’ve changed my future contributions, but I haven’t changed existing holdings. Previously I was putting 75% of contributions into Harbor International Fund and 25% of contributions into Fidelity Freedom 2040. Fidelity Freedom funds are “funds of funds” that have holdings in stock funds and bond funds in proportion to an expected retirement date, in this case with retirement in 2040. Going forward I’m putting half my contribution in Fidelity Freedom 2040 and half in the money market fund. Again, when the downtrend is over I’ll move the money market holdings to something that will take advantage of an upward market.

I don’t believe I’ll actually make money while the market is falling but I certainly won’t lose as much, and I’ll be in good shape when things turn around. I have no illusions that I can time the market, so I don’t expect to catch the entire move up when things change. But I do expect to protect my holdings so that I’ll have more when things turn around.

1. I hated having a $23,000+ credit card balance out there
2. I didn’t have anything better to do with my money for the next 2 months

Sure I could have plopped it in savings and earned another $100 in interest, but having the monkey of the credit card off my back was worth far more than $100 to me.

Now we just have a small balance at 0% on a Home Depot card. The money there was spent finishing the closet in our master bedroom. The 0% offer on that card ends in two stages, one on 1/1/09 and the rest in March 2009. Our current plan is to pay the entire balance off near the middle of November. Then it’s back to the usual, piling up cash.