That 8% Long Term Returns
Good Sunday to all. I feel many of you guys who were approached or would approach a financial advisor would most likely be shown a projected returns table telling you why you should put your money into this fund and that fund, or this ilp with these 2 funds in it.
I used to think that these figures can’t be trusted. The reason being that such figures are taken when the times are good and good times do not last forever. Well, i think the bear market these 2 years have shown us that buy and hold can really f*ck us up real bad.
It took me some time but i am glad that i realise that while looking at each of the stocks in your basket is important, nothing can be more than viewing the environment your basket is on! This is where many wannabe investor like me failed to see or are too late or too stubborn to accept it.
We been sold too much by the good axioms of Warren Buffett investing, Dividend Investing and Growth investing and failed to see that sometimes the world is bigger than just finance. This is why financial decisions becomes difficult to make and why there are people that got rich through investing and those that got poorer by taking the wrong steps.
Back to that 8%. I read this interesting article written by John Mauldin and he basically dissected this common sales pitch and come to a conclusion that using one tool to get 8% is not very possible.
For those who are lazy to read every thing, I created a mind map of it. Do download it and get the geeze of it.
“Stocks for the long run” has been weighed in the balance in Baby Boomers’ retirement accounts all over the world and has been found wanting. The S&P 500 is now roughly where it was 12 years ago, although earnings in 1997 were higher than those projected for 2009. The Dow closed at 7466 on Thursday, a six-year low, giving all those who follow Dow Theory a clear bear market signal, suggesting there is more pain ahead.
In 1997 I was a young 49. For me to make the advertised 8% average annual returns in my equity portfolio, the Dow would have had to go on a tear for the next 8 years. 8% compound from 1997 would have the Dow well over 30,000 now. Remember those silly books which predicted such nonsense? (Seriously, what statistically flawed analysis, yet people bought it.) Now the market would have to do 18% a year for the next 8 years to get to 30,000. Anyone want to make that bet? Let’s look at a few paragraphs I wrote in Bull’s
Eye Investing.
Living in Paradise
Would you like to live in paradise? There’s a place where the average daily temperature is 66 degrees, rainy days only occur on average every five days, and the sun shines most of the time.
Welcome to Dallas, Texas. As most know, however, the weather in Dallas doesn’t qualify as climate paradise. The summers begin their ascent almost before spring arrives. On some days the buds almost wilt before turning into blooms. During the lazy days of summer, the sun frequently stokes the thermometer into triple digits, often for days on end. There are numerous jokes about the Devil, hell, and Texas summers.
Once winter arrives, some days are mild — perfect golf weather. Yet the next day might be frigid, with snow or the occasional ice storm. That’s good for business at the local auto body shops, though it makes for sleepless nights for the insurance companies. Certainly the winters don’t match the chilly winds of Chicago or the blizzards of Buffalo, but Dallas is far from paradise as its seasons ebb and flow.
For the year though, the average temperature is paradisical.
Contrary to the studies that show investors they can expect 7% or 9% or 10% by staying in the market for the long run, the stock market isn’t paradise either. Like Texas summers, the stock market often seems like the anteroom to investment hell.
Historically, average investment returns over the very long term (we’re talking 40-50-70 years) have been some of the best available, but the seasons of the stock market tend to cycle with as much variability as Texas weather. The extremes and the inconstancies are far greater than most realize. Let’s examine the range of variability to truly appreciate the strength of the storms.
In the 103 years from 1900 through 2002, the annual change for the Dow Jones Industrial Average reflects a simple average gain of 7.2% per year. During that time, 63% of the years reflect positive returns, and 37% were negative. Only five of the years ended with changes between +5% and +10% — that’s less than 5% of the time. Most of the years were far from average — many were sufficiently dramatic to drive an investor’s pulse into lethal territory!
Almost 70% of the years were “double-digit years,” when the stock market either rose or fell by more than 10%. To move out of “most” territory, the threshold increases to 16% — half of the past 103 years end with the stock market index either up or down more than 16%!
Read those last two paragraphs again. The simple fact is that the stock market rarely gives you an average
year. The wild ride makes for those emotional investment experiences which are a primary cause of investment pain.
The stock market can be a very risky place to invest. The returns are highly erratic; the gains and losses
are often inconsistent and unpredictable. The emotional responses to stock market volatility mean that most investors do not achieve the average stock market gains, as numerous studies clearly illustrate.
Not understanding how to manage the risk of the stock market, or even what the risks actually are, investors too often buy high and sell low, based upon raw emotion. They read the words in the account-opening forms that say the stock market presents significant opportunities for losses, and that the magnitude of the losses can be quite significant. But they focus on the research that says, “Over the long run, history has overcome interim setbacks and has delivered an average return of 10% including dividends” (or whatever the number du jour is. and ignoring bad stuff like inflation, taxes, and transaction costs).
The 20-Year Horizon
But how long is the “long run”? Investors have been bombarded for years with the nostrum that one should invest for the “long run.” This has indoctrinated investors into thinking they could ignore the realities of stock market investing because of the “certain” expectation of
ultimate gains.
This faulty line of reasoning has
spawned a number of pithy principles, including: “No pain, no gain,” “You can’t
participate in the profits if you are not in the game,” and my personal
favorite, “It’s not a loss until you take it.”
These and other platitudes are often brought up as reasons to leave your money with the current management which has just incurred large losses. Cynically restated: why worry about the swings in your life savings from year to year if you’re supposed to be rewarded in the “long run”? But what if history does not repeat itself, or if you don’t live long enough for the long run to occur?
For many, the “long run” is about 20 years. We work hard to accumulate assets during the formative years of our careers, yet the accumulation for the large majority of us seems to become meaningful somewhere after midlife. We seek to have a confident and comfortable nest egg in time for retirement. For many, this will represent roughly a 20-year period.
We can divide the 20th century into 88 twenty-year periods. Though most periods generated positive returns before dividends and transaction costs, half produced compounded returns of less than 4%. Less than 10% generated gains of more than 10%. The P/E ratio is the measure of valuation reflected in the relationship between the price paid per share and the earnings per share (”EPS”). The table below reflects
that higher returns are associated with periods during which the P/E ratio increased, and lower or negative returns resulted from periods when the P/E declined.
Look at the table above. There were only nine periods from 1900-2002 when 20-year returns were above 9.6%, and this chart shows all nine. What you will notice is that eight out of the nine times were associated with the stock market bubble of the late 1990s, and during all eight periods there was a doubling, tripling, or even quadrupling of P/E ratios. Prior to the bubble, there was no 20-year period which delivered 10% annual returns.
[Continue Reading at The Big Picture]
Related posts:
- Carl Swenlin:EMA cross over signals Long Term Bull
- Long Term Market Analysis: Some insights into the rally intensity of this bull run
- S&P 500 Long Term Trends
- Do new index stocks bring better returns?
- A possible long term strategy
If you enjoyed this post, please consider to leave a comment or subscribe to the feed and get future articles delivered to your feed reader.
Comments
No comments yet.
Leave a comment