Long time reader Leisa left an interesting passage from a white paper of sorts that challenges the assumption that the stock market returns 10% per year over long periods of time.
Asking questions about these sorts of truisms is always worthwhile and something I should do more of on the blog.
Before I get too into this let me say a little something about where I am coming from professionally and personally.
Professionally I am just trying to help people get to where they think they need to be over the time period they need. Because I spend 75 hours a week (my wife's count) on this endeavor I feel like I am doing the best I can to find and understand different asset classes and countries to own. I can guarantee no result but the effort is exhaustive.
I don't care about ever writing a white paper or other research. I deal with people and their money so too much focus on academic issues becomes a distraction from the way I think the job should be done.
I certainly will not have any definitive answers here just how I look at the possibility and as Leisa says, maybe this can spur some good discussion.
Personally we save as much we can, live below our means and I hope to continue my work until the end. If somehow returns from the capital markets are not what my plan calls for I will save more. We have created a lifestyle that will accommodate this should it ever become necessary.
The paper linked to above notes that from 1900 through to 2002 the average return from 16 different countries was 5% before fees and taxes. The excerpt does not disclose the 16 countries but from a kick-the-tires viewpoint I am not sure there is much value in studying all but the two or three biggest markets from the period before World War II. How developed where these markets in the teens and 20's? The notion of evolution and modernization has to matter some doesn't it? For some perspective on this point as recently 1960's the US market closed early on Wednesday's to catch up on paperwork.
Below are the closing levels of the S&P 500 every ten years starting with 1930 according to the Trader's Almanac.
1930 25.92
1940 12.77
1950 20.43
1960 60.39
1970 93.46
1980 140.52
1990 368.95
2000 1527.46
A statistic I recall from my time at Fisher Investments was that stock outperformed bonds over 15 rolling year periods what I believe was 92% of the time.
Above I mentioned evolution. This is a word I have used many times before in writing about investing. Capital markets and investment products evolve. If this is true then it must also be true that portfolio construction must also evolve. I have been writing from the start of this blog that future investing success will have to come from a willingness to own new, to you, investment destinations and new, to you, asset classes.
To the extent the white paper is correct, one focus of this blog has been the exploration of many different investment themes that are somewhat, if not entirely, consistent with the conclusion drawn. To the extent the white paper is wrong challenging generalized assumptions with some real depth should make you more knowledgeable about markets and portfolio construction.
One last point, as you navigate through the markets over time wrap your hands around the possibility that you will need to save more.
20 comments:
Good morning.
Any thoughts on the usefulness of principal-protected notes (a combination of a zero coupon bond and an option on a specified underlying index) in a portfolio ?
BTW, this is my favorite blog.
principal-protected notes that trade on an exchange always seem to be very complex, unless something has changed very recently. The seem to no allow for 100% participation on the upside, but of course they insulate the downside too.
replicating the strategy yourself could make sense using a futures contract but the mechanics of the futures market could hurt returns.
I think there are a couple of OEFs that do this sort of thing too.
Candidly I don't have much to say about this as it strikes me as the sort of thing that can go wrong and more importantly I believe a diversified portfolio is a better way to go.
Just wanted to point out that the cited paper claims an expected *real* equity return of 5%. So if we assume inflation of ~2.5%, then the paper claims a nominal equity expected return of ~7.5%. Personally, I think that's a more realistic expected future return than 10% nominal, and that's the number I assume for my own retirement calculations.
My novice perception of Roger's portfolio process is that personally I could not accept anything close to 20%loss as normal. I'm only 57 and while I could have many years ahead it's not the same as being 37. RW has better expressed this sentiment. But, I do see a "diversified portfolio" as reasonable and correct to have within one's total holdings...ala tomk. And, if I may toot Roger's horn..a weird phrase, but anyway, after scouting around for asset mgrs Roger does add unique value to his approach. He is heavily into the global and thematic picture, systematic, and rooted to only increase his knowledge and network base while most just give lip service to it and pass on the legwork and fees to a mutual fund. Personally, i'm in the camp that says diversification is not complete, until one includes multiple strategies besides multiple asset classes. The ones that appeal to me are microcaps/speculative holdings that require an ability to sift through a lot of bs story stocks and the skill to trade partial positions in order to scalp profits during which could be a long and volatile incubation period. Another strategy is the old school value approach and buying depressed out of favor stocks. A third strategy is tom k's example of tactical asset allocation (growth variation). A fourth strategy would be private placements...which is really another asset class. A fifth style or strategy would be contrarian...more sector based that the value bottoms up approach. Come the day, hopefully, when I have enough to start this multi prong approach, Roger has a lot of appeal not that he needs me to say so. Back to that thorny issue of a benchmark, on further thought as prospective client I would look for a lipperesque average of mgrs whose mission statement is diversification....ps. i'm also a big fan of leisa's well thought out position statements..wow, that gal can write.
Although I question the method and conclusion in the paper Leisa cites, I agree investors are better off if they have a realistic expectation of future equity returns and in some way plan for a long period underperformance.
I'm a big fan of Paul Merriman and generally agree with the conclusions of Fama an French, but the data set used as the basis for most "lazy portfolios" is incredible short. Although I think it is very unlikely, who's to say global equities won't tread water over the next 30 years?
I agree wholeheartedly with anon 9:43 - strategy diversification is every bit as important as asset class divesification. It provides the peace of mind to stay disciplined to executing each strategy with the expectation that one or more may underperform over a considerable period of time.
Roger and readers--thanks for giving this a twirl.
Anon:9:43--your comments were kind. Thank you.
the table that Roger posted shows that the 10% assumption is heavily skewed by the abnormal results of the 90's bubble... if anything it is more of a reason to not assume any rate of return based solely on historical data.
Sami,
wouldn't the 1950's and 1980s also skew, making it three out of 7 where the 10% assumption works?
There are then three others where the market went up in the neighborhood of 50% total which is not horrible when weaved in to a long term time horizon.
The study reminds me of the old saying - something like this -
"if history was all that was important, librarians would all be millionaires"
I really like Anon 9:43's concept of Strategy Diversification in addition to Asset Class Diversification.
OG
OG,
That was me with multi strategy approach...for the fun of it, a lazy port based on something like it?
...jasper...for life of me I can not get the google account to work.
MikeC.
I know this is way off topic, but what do you, or Roger for that matter, think of Jim Roger's new commodity ETN. RJI?
http://tinyurl.com/34p9ry
The key point of the paper is that if you had invested in US or UK stocks then you would have done fine, but if you had invested in German stocks at the beginning of the 20th century on a buy and hold basis then you would have been wiped out. People think US or UK stocks are safe for the long-run but maybe that is just survivor bias. The German economy looked very strong in the early 20th century too. Who knew about the coming hyperinflation and then the Second World War. My father was born in Frankfurt in 1916 so this experience feels very real to me.
I wrote about the Rogers commodity ETNs for TSCM.
Triumph of the Optimists: 101 Years of Global Investment Returns (Hardcover)
The authors of the study that I cited wrote the above. I suspect that the paper is a distillation of the research that spawned the book.
The 1990 - 2000 numbers reflect what kind of crazy bubble we are in, worst in history.
Exactly why I'm short equities. Thanks.
My financial advisor is quite receptive to the idea of strategy diversification. PowerShares ETFs are an interesting starting point for me (don't mean that as a tout, Roger, just a provider who has pioneered in that arena.) It would be easy enough to construct a lazy strategy portfolio using their products. I'm toying with something like that for the non-core portion of my portfolio.
Thanks Roger.
And Anon 7:54, your head must be made of solid bone.
MikeC.
I know this is way off topic, but what do you, or Roger for that matter, think of Jim Roger's new commodity ETN. RJI?
I don't know enough about that specific ETN to really offer a strong opinion. It looks like just another alternative to get broad commodity exposure.
I could be wrong on this view, but in general I don't like the ETN concept because you don't actually own an underlying basket of securities like an ETF. The ETN is just a debt obligation of whatever institution is issuing it. What happens if the institution has a meltdown? What happens to the value of the ETN? I'm not sure.
Sometimes, in my view the easiest choice is to stick with the tried and true as opposed to venturing into new products with some "issues". There are PLENTY of mutual funds and ETFs that one can you use to get commodity exposure so I just don't see the point of going the ETN route. I could be overly skeptical here, but it is ONLY what you own that can hurt you, not what you don't own.
Regarding long-term equity returns, there are numerous academic/scholar types that have argued that U.S. equity returns going forward MUST be lower then the historical average of 10-11%. Really, it's just simple math. Returns can be decomposed into multiple expansion/contraction, earnings growth and dividend yield.
Earnings growth is pretty reliably 6% over the long-term. Current S&P 500 dividend yield is 1.9% which is WELL below the historical averages. Current multiples leave little if any room for multiple expansion. My own view is we will either have a substantial bear market or years of sideways action to bring long-term expected returns back higher again.
But that is for the broad U.S. market. One can do better through individual country/fund/ETF/sector/stock picking then the broad U.S. market.
I think strategy diversification makes a ton of sense. At the most basic level, I think it means having some exposure to the value/contrarian strategy and some exposure to a growth/momentum strategy. One can look at different mutual funds that use completely different strategies yet have track records of long-term outperformance.
The turkey index(price change of turkey or turkey dinner from a year ago) is 11% higher. Regardless of what CPI says, the purchasing power here has probably dropped by 11% or more. Just look at the prices of milk, eggs, gas, and steaks. I think the challenges for todays's investors are price inflation and economic recession. I hate to say 7-10% gain a year probably won't cut for the next decade? Any thoughts on boosting the return to 12-15% annually without taking too much risk?
Thanks Mike.
As for the last post, my answer would be that if you find out how yourself you can make millions selling your how-to book and not have to worry about inflation.
JackS
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