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The Cobra Effect

Mar, 09/05/2017 - 12:50
The Law of Unintended Consequences and the Risk of Owning BondsPhoto: Pixabay

When the British occupied India under colonial rule in the mid to late nineteenth century, they had a problem — Cobras. These venomous snakes were numerous in India and, unsurprisingly, the British were not fond of them. As a result, the British government set up a program by which they would pay anyone to bring them a dead cobra. Initially, this worked wonders as dead cobras started flooding in. However, after some time, the British discovered that some of the Indians had played a trick on them.

Indians looking to cash in on the cobra buyback program setup cobra farms to breed cobras. These cobras were killed and given to the British for the bounty. As soon as the British discovered this cobra farming scheme, they ended the buyback program. Indian cobra farmers, with no other use for the cobras, abandoned their operations and set the cobras free. As a result, the number of cobras in India increased.

This is called the cobra effect and perfectly illustrates the law of unintended consequences. While no one knows if this story is true, there are plenty of examples that mirror its result, namely, individuals making decisions to cause one outcome to occur can accidentally cause the opposite. The cobra effect is hard to foresee before hand and appears quite often in the investing world. And that is what I am here to talk about today.

If we took a high level tour of the greatest investing blunders of all time, I would argue that they all suffered from the cobra effect. Given that the strict objective of investing is to get wealthier, I cannot imagine a more unintended outcome than losing vast sums of money. However, I don’t want to talk about get rich quick schemes or penny stocks. The cobra I want to talk about today is bonds.

What words come to your mind when I say “bonds”? Safety? Low risk? Principal preservation? These are all generally true…in the short run. Over longer periods of time, bonds have simply been ineffective at building wealth. And with today’s very low yields, your return on bonds after inflation and taxes is essentially 0%. So, unless you require 0% returns going forward (i.e. you have more money than you could ever need), you need to hold ample amount of equities. For example, the average real return on 10-year U.S. bonds from 1928–2016 was 2%:

While this isn’t 0%, this 2% is being heavily skewed by the higher bond returns starting in the early 1980s. If we look at the returns by decade you can see that for 4 decades, starting in 1940 and ending in the late 1970s, annualized bond returns were negative or close to 0%!

As you can see, besides the 1980s where bond yields were through the roof, the long term record for bonds is quite unimpressive. Therefore, all of your long term capital preservation and growth will need to come via equities or equity-like investments (i.e. REITs, etc.).

So how does the cobra effect occur with bonds? Retirees, scared of losing principal, might shift all of their assets into CDs and Treasuries for “safety.” For the first decade or so 100% in bonds works fine, but, as the retiree ages, the scourge of inflation and taxes slowly dwindle away their nest age and the probability of running out of money starts to sky rocket. The decision to provide safety has made the retiree less safe in the long run. Nick Murray puts it best in his book Simple Wealth, Inevitable Wealth:

You can have blissful emotional and financial security on this end of your remaining lifetime — right here, right now. We’ll get you some money market funds, a six-month CD, Treasury bills, and maybe some very high grade corporate bonds maturing in the next five years. The number of currency units you’ve got will hardly fluctuate at all. You’ll get a little current income, and you will sleep like a baby. Of course, one day — and that day may not come for twenty years or more — you’ll run out of money. Perfect security on this end of your investing lifetime; total insecurity (indeed, disaster) on the other end.

He continues (emphasis his):

There is no such thing as no risk. There’s only this choice of what to risk, and when to risk it.

The risk of owning bonds shows up later in your investment life, while the risk of owning equities can show up much earlier. And why should we expect anything different? As someone who wants to build and keep wealth, you should expect to go through a handful of periods where you might be down 40%+. This is the nature of investing. If you don’t want the volatility, then you deserve the meager result you will surely obtain. In the case of a 100% bond portfolio, we could re-imagine a famous Benjamin Franklin quote:

Those who give up return for security deserve neither return nor security.

How To Use Bonds Effectively

For the record, I am not against holding bonds in a portfolio. I am just against holding 100% bonds, unless you have sufficient capital such that your returns don’t matter. I also can’t tell you what % of your portfolio should be in bonds, as this would require me to know your goals, temperament, and individual circumstances. However, I can say with some level of certainty that bonds will not be a builder of wealth going forward.

Despite the bad rap I have given to bonds, I do think there are effective ways of using them. For example, I currently hold ~20% of my net worth in bonds though I am only 27. Some might say that is stupid given the amount of time I have for equity compounding, but I hold bonds for 2 reasons:

  1. To dampen volatility during downturns.
  2. As a form of liquidity to rebalance back into stocks during these downturns.

Since investing is primarily a behavioral exercise, not an analytical one, bonds can act as a form of insurance against panicking when there is blood in the streets. The fact is that I don’t know how I will react during a 30%+ drawdown, since I haven’t experienced one yet. Therefore, I am using my bonds as an experiment on myself to see how I will react when a larger drawdown does eventually occur. If I play it cool, I will likely reduce my bond exposure in the future. The key is to know yourself as an investor. Thank you for reading!

➤ If you liked this post, please consider sharing on Twitter, Facebook, or LinkedIn.

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This is post 37. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data

Disclaimer

The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. The postings on this site are my own and do not necessarily reflect the views of my employer. Please read my “About” page for more information.

OfDollarsAndData.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com and affiliated sites.

The Cobra Effect was originally published in Of Dollars And Data on Medium, where people are continuing the conversation by highlighting and responding to this story.

Falling Fast and Rising Slow

Mar, 08/29/2017 - 12:59
On the Nature of Equity Price Declines and RecoveriesPhoto: Pixabay

This week’s post concerns something that is well known to many investors: stock prices fall quickly and recover slowly. However, my real question is: how long, on average, does it take for the decline and subsequent recovery to occur?

To begin, let’s consider the following thought experiment:

Imagine you are magically transported to some month between 1920 and 2016 where the U.S. stock market just hit an all time high and we know with certainty that the market is going to drop 20% (i.e. a 20% drawdown) in the very near future. My question is:How long, on average, would it take before you were down 20%?And the more important follow-up question: Once you are down 20%, how long will it take to recover (i.e. reach a new all time high)?

I used Shiller’s U.S. stock market data and found that it would take, on average, 7 months before you declined 20% or more and 6 years to recover from that decline. The asymmetry in the results might surprise you, but you need to remember that once you have experienced a 20% drawdown, the market can always fall further. The nasty can always get nastier. [Side note: I use the Shiller U.S. stock market data a lot, but the more I torture the data, the more it seems to confess different financial insights!]

To provide more statistics on this, below you will find a table that shows, for various drawdown levels, the median number of years it would take to fall from a peak (column [A]) and to recover from that fall (column [B]). I used the median instead of the average to reduce the skew from outliers. Lastly, please ignore column [C] for now, as I will address it shortly.

As you can see, when we know in advance that a certain drawdown will occur, the amount of time to experience such an event (column [A]) is usually quite short. While a 20% drawdown would take 6 months (0.5 years), a 50% drawdown takes about 2 years to unfold. However, given how small our sample size is (i.e. there are only three 50%+ drawdowns in the data), these statistics will likely not be helpful for understanding future market behavior.

If you focus your attention on column [B] you will notice that the time to recover once you have experienced a particular drawdown is much larger than the fall time (column [A]). This is true because many smaller drawdowns can become larger as markets get more chaotic. In other words, every 50% drawdown was once a 5% drawdown.

Though this data suggests that once you are at a peak that drawdowns happen quickly, I will admit there is some selection bias going on with column [A]. I stated that the drawdown had to be known beforehand. However, this is never the case. Many times, when you are at a peak, in the next few months you will likely hit an even higher peak. Therefore, I need to correct for this selection bias.

In order to do this, I created column [C] to allay any fears. Column [C] provides the median number of years from any peak to a specific drawdown level. So, given you have hit a random all time high, it would take roughly 5 years before you experienced a 20% drawdown. This time period is much longer than the one in column [A]. Why? Drawdowns, especially larger ones, have been historically rare.

To provide a better visual aid to this, let’s look at a log plot of the S&P 500 real price + dividends from 1920 to 2016. I have shaded this plot red whenever the market falls 20% and green from the moment after it falls 20% until its next all time high. Therefore, the red bars represent declines and the green bars represent recoveries.

As you can see, there is far more green then red in this chart, which illustrates the point of this post. You may also notice that some of the declines happened so quickly that the red bars don’t plot well on the chart. For a clearer visual, consider the same plot with 40% drawdowns:

The most interesting thing about this plot to me is that the recovery from the dotcom bubble in 2000 was the longest in U.S. stock market history, after adjusting for inflation. From the peak, it took roughly 13 years before the highs of the dotcom bubble were reached again.

The Stock Market is Like a Ladder

Some of you may be wondering why I had a picture of a ladder at the beginning of this post, and the reason is that it seems to be a decent, though imperfect, analogy for equity price behavior. Prices go up slowly, like someone climbing a ladder. However, once in a while, people slip and the subsequent fall occurs much faster than the climb up. Unfortunately, depending on the damage suffered from the fall, some investors decide to never get on that ladder again.

This was a fun exercise to do, but may not provide much value in the future if market behavior differs from its own history. For example, in modern markets, individuals and machines better understand the concept that the U.S. stock market has, historically, always recovered. As a result, future recoveries may happen more quickly or larger drawdowns may be prevented altogether.

Lastly, the impact of peaks and drawdowns will not be as extreme for the investor that is dollar cost averaging. All of the recovery times above assume that you bought in at the peak. However, if you are using just keep buying or a similar strategy, your cost basis will be lower and your recoveries relative to this cost basis will be shorter. With that being said, remember to enjoy the slow ride up and don’t fear the roller coaster like drops when they occur. Thank you for reading!

➤ If you liked this post, please consider sharing on Twitter, Facebook, or LinkedIn.

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This is post 36. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data

Disclaimer

The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. The postings on this site are my own and do not necessarily reflect the views of my employer. Please read my “About” page for more information.

OfDollarsAndData.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com and affiliated sites.

Falling Fast and Rising Slow was originally published in Of Dollars And Data on Medium, where people are continuing the conversation by highlighting and responding to this story.

When There is Blood in the Streets

Mar, 08/22/2017 - 12:53
Why Following Advice During a Financial Panic is Not as Easy as it SoundsPhoto: Wikimedia Commons

There is a famous quote by the 18th century banker Baron Rothschild:

The time to buy is when there’s blood in the streets.

Rothschild made a lot of money in the panic that followed the Battle of Waterloo using this exact motto. However, his advice is far easier said than done. I’ve noticed this problem within the personal finance/investing community that seems to suggest that a few common rules can solve almost all of your financial problems. The issue is that it is far easier to memorize a simple catch phrase that looks good retrospectively, than to act on the same advice in the moment. I will expand on this point later, but first…some data.

Let’s consider the drawdowns on the S&P 500 since the late 1920s. For a short refresher, a drawdown is any decline from an all time-high. Therefore, if a stock is at 100 and falls, that stock is in a drawdown until its price is above 100. More importantly, I want to focus on times when there is “blood in the streets” as Rothschild’s quote suggests. Though there is no formal definition for this, I am going to propose that any drawdown greater than 30% can be considered a “blood in the streets” moment. As you can see below, the S&P 500 has had 6 initial drawdowns of greater than 30% since the late 1920s (the dark points represent the month where the drawdown first exceeded 30%):

In addition to these 6 drawdowns of over 30%, there were 4 occasions where the S&P 500 had a drawdown of over 40%, and 3 occasions where it had a drawdown of over 50%. While we cannot predict the frequency of future drawdowns or their magnitude, if history is any guide you should plan for four 30%+ drawdowns and two 50%+ drawdowns in equity markets over a 50 year investment life. I don’t know when (or if) they will happen, but this is a fair expectation given market history.

So what’s it like when there is blood in the streets? To imagine this, I have gone back through the data and aligned and indexed every market peak for the most famous U.S. stock market crashes. This means that from each all time high, we can see the crash play out. It will allow us to easily compare the 1929 crash to the crashes in 1974 (peak was in 1973), 1987, 2000, and 2008 (peak was in 2007). Below are the 5 peaks aligned to start at 100 and play out over time. You can see which line corresponds to which peak using the year showing up on the far right side of the plot:

As you can see, each market crash behaves different especially as time goes on. For example, the Great Depression and the Dotcom bubble both didn’t see the bottom until ~3 years after their respective peaks, while the crash of 1987 quickly resolved itself and was above its old peak within 2 years.

If we expand our time horizon to look out over a a 10 year period, we see a few very interesting things about these same stock market crashes:

The most important thing I learned from this data was that the Dotcom bubble combined with the Great Recession of 2008 placed the U.S. stock market in a similar place to the Great Depression 10 years after its beginning. Now I am not saying that both events exhibited the same level of financial chaos, because they didn’t. Looking at the Great Depression you can see that the green line is far lower for far longer than the black line (Dotcom bubble). This exemplifies how the experience of the Great Depression was far worse than the Dotcom bubble + Great Recession, despite the real price changes ending up around the same place 10 years later. This is intriguing even though it is likely pure coincidence.

Now this is where the “blood in the streets” quote will fail you. Imagine being 1 year into the Great Depression. By our definition, there was “blood in the streets” as there had already been a 30% drawdown in the U.S. stock market. However, the market would continue to decline for another 2 years, with a 64% decline in the last year! Though you might start buying when there is blood in the streets, you may soon realize that a lot of that blood is your own.

This is the fundamental problem with buying big during a crash. It’s incredibly difficult to call the bottom. So if you try to wait it out you will either miss it completely (i.e. staying in cash for too long), or you will buy before the true bottom and could lose money if you sell at lower prices. Either way, the best action is no action at all…

Don’t React When the Streets Run Red

If there is any advice I would follow during a panic, it would be to not react to it. By reacting you are far more likely to make a decision that loses you money than one that will help you. Assuming you have a sufficient level of liquidity in an emergency fund, I would continue buying assets at the same rate during a financial panic as you did before the panic. Yes, just keep buying is here again.

If you don’t believe me, consider the words of Charlie Munger, Warren Buffett’s acclaimed business partner. Munger stated the following at the beginning of an interview with the BBC:

If you’re not willing to react with equanimity to a market price decline of 50% two or three times a century, you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get.

Munger and Buffett are known for buying when prices are depressed, but I still do not advise this course of action for an average investor. The problem is that they have the extra capital to buy cheaper assets, but you probably don’t. Your extra capital may be needed for liquidity purposes during an emergency (i.e. job loss, etc.), but this is something that only you would know. While you may commit now to not act during the next panic, I doubt it will be easy when the time comes. Thank you for reading!

➤ If you liked this post, please consider sharing on Twitter, Facebook, or LinkedIn.

➤ You can follow Of Dollars And Data via Email (1 weekly newsletter), Facebook, Twitter, or Medium.

This is post 35. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data

Disclaimer

The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. The postings on this site are my own and do not necessarily reflect the views of my employer. Please read my “About” page for more information.

OfDollarsAndData.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com and affiliated sites.

When There is Blood in the Streets was originally published in Of Dollars And Data on Medium, where people are continuing the conversation by highlighting and responding to this story.

Cooperation in the Age of Anger

Mar, 08/15/2017 - 12:58
Why We Need Understanding And Support For Others Now More Than EverPhoto: Pixabay

I have finally cracked. After writing for Of Dollars And Data for 33 weeks without discussing politics in the slightest, I have had enough. I really thought I could keep this website strictly to personal finance/investing, but I don’t have the will to write about tax loss harvesting while nuclear war threatens our very existence and the political divide in this country grows wider. I want to talk about both of these topics today and why we need to have more understanding and support for those that hold worldviews different from our own.

1. The Most Important Data Series

To start, I want to talk about arguably the most important data series that the world has ever known:

This is it. 2 data points in 1945 during World War II and zero ever since. Keeping that line at zero is the most important thing that we can do to ensure the future of our species in the near term. Don’t get me wrong, we still need to fix other problems (i.e. the environment, inequality, etc.), but none of those present the short term existential crisis that nuclear war does. It has been over half a century since the world was at such a crossroads. The Cuban Missile Crisis of 1962 was the closest we ever got to full blown nuclear war. Though I don’t think North Korea presents the same existential threat today that the USSR did in 1962, any nuclear attack would be devastating. Even one bomb is too many.

So why does North Korea have such a troubled relationship with the U.S.? It is a complex answer, but it all goes back to the Korean war. Did you know that the U.S. dropped 100,000 more tons of bombs on North Korea from during the Korean War than they did in the Pacific during all of World War II? How about that approximately 20% of the North Korean population was killed in the Korean war? I am not saying that these facts excuse the behavior of the North Korean regime, but this context matters a lot.

I don’t know enough about the U.S. relationship with North Korea to say anything noteworthy, but I am for any solution that will prevent the loss of life, especially from a nuclear attack. I can only hope those in both governments feel the same way.

2. Befriend Your Enemy

Whether the nuclear threat ever materializes, there is still a growing political and ideological divide across America. All political discourse seems to have lost its civility. Yelling has taken the place of finding common ground to build a productive relationship. I do not know much about politics, but I can say this with certainty: The more forceful an opposing point is presented to an individual, the more likely that individual will reaffirm their original belief. This means that the argumentative nature of today’s political discourse is actually making things worse and there are plenty of psychological studies about confirmation bias to support this.

So what can you and I do about it? Stop the yelling, try to seek understanding, and support your fellow Americans as people. Yes, all of them. Even the white supremacists out in Charlottesville, as much as you might hate them, deserve to be treated fairly as people. I don’t agree with their views, but I would seek to understand why they have those views. You might think they hold these views because they are “bad” people, but thinking like this is both inaccurate and unhelpful for making progress.

Understanding individuals as people and befriending them is a far more useful tactic for reducing hate than any form of argument or violence. If you don’t believe me, consider the story of Daryl Davis, an African-American blues musician who befriended over 200 members of the KKK and got them to disavow the Klan. Davis never pressured any of these men to leave the KKK, but they left nonetheless. Davis simply asked them, “How can you hate me when you don’t even know me?” The fact is that Daryl Davis figured it out:

Hate needs to be hugged, not choked, out of existence.The Story of Humanity is the Story of Cooperation

Despite the grim picture I have painted about human cooperation, the world has gotten more, not less, cooperative over the last few hundred years. To illustrate this, I will leave you with one of my favorite ideas in all of economics that exemplifies the power of human cooperation through the free market.

There is an essay called, “I, Pencil” by Leonard Read that Milton Friedman summarizes incredibly in this video. Friedman discusses how something as simple as a pencil could not be created without lots of human cooperation. The amount of things that need to be accomplished to create a pencil (i.e. chop down a tree, grow rubber, mine brass, etc.) are far too vast for any one person. He expands on this idea eloquently:

Literally thousands of people cooperated to make this pencil. People who don’t speak the same language, who practice different religions, who might hate one another if they ever met! When you go down to the store and buy this pencil, you are in effect trading a few minutes of your time, for a few seconds of the time of all those thousands of people. What brought them together and enduced them to cooperate to make this pencil? There was no Commissar sending out orders from some central office. It was the magic of the price system. The impersonal operation of prices that brought them together and got them to cooperate to make this pencil so that you could have it for a trifling sum. That is why the operation of the free market is so essential, not only to promote productive efficiency, but even more, to foster harmony and peace among the people of the world.

Free markets are not perfect, but they are the best thing we have tried to encourage massive levels of cooperation across the world. So don’t fret. We are moving in the right direction despite the occasional speed bump along the way. As Josh Brown explained so well recently, this is just a counter-trend.

Call to Action

Instead of asking you to share this story, I want you to actually do something that helps you and increases the amount of cooperation in the world. Find someone that you had a falling out with and reach out to them. Estranged relative? An old friend? I don’t care who it is, but please find it in your heart to forgive this person or to apologize to them if you did something wrong. Try and mend some old wounds. I am asking you this favor as a brother, a son, a friend, and, most importantly, as a human on this planet. The world is so filled with hate and anger right now that I just want to know, “Where is the love?”

Thank you for reading!

➤ If you liked this post, please consider clicking the ❤️ below or sharing on Twitter, Facebook, or LinkedIn.

➤ You can follow Of Dollars And Data via Email (1 weekly newsletter), Facebook, Twitter, or Medium.

This is post 34. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data

Disclaimer

The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. The postings on this site are my own and do not necessarily reflect the views of my employer. Please read my “About” page for more information.

OfDollarsAndData.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com and affiliated sites.

Cooperation in the Age of Anger was originally published in Of Dollars And Data on Medium, where people are continuing the conversation by highlighting and responding to this story.

Retiring Off Dividends: What Are the Odds?

Mar, 08/08/2017 - 12:59
A Simulation of Retirement Dividend Income Using Varying Savings Rates and Time HorizonsPhoto: Pixabay

This is a guest contribution by Nick McCullum from Sure Dividend. Sure Dividend uses The 8 Rules of Dividend Investing to systematically identify high-quality dividend stocks suitable for long-term investment.

Investing in the stock market has historically been one of the best ways to build long-term wealth.

We can take this a step further — instead of just growing wealth, dividend stocks are one of the best ways to generate income.

In fact, the end goal of many dividend growth investors is to create a dividend stock portfolio (composed of ETFs or even individual stocks) that generates enough income to cover their retirement expenses.

With that in mind, this article investigates your chances of retiring off of dividend income using different savings rates and time horizons.

Some Benchmark Parameters & Assumptions

If you are investing in broad-based index ETFs (which is a great choice for the vast majority of investors), then the two most important factors in your long-term investment success are:

  1. Your savings rate
  2. Your time horizon

Because of the importance of these two metrics, they are the two main variables that I will tweak in this analysis.

More specifically, I will consider savings rates from 10%-50% (using incremental of 10%) and time horizons ranging from 45 year to 15 years (using 5 year increments). Using the traditional retirement age of 65, this implies a starting investment age of 20 to 50.

This analysis will estimate future investment returns by fitting a normal distribution through the historical returns of the S&P 500 Index ETF, which trades under the ticker SPY on the New York Stock Exchange.

SPY is a great investment option for long-term investors seeking broad-based equity exposure. In fact, Warren Buffett recommends a portfolio containing 90% SPY and 10% in short-term government bonds for the average U.S. investor with no financial experience.

Since 1993, SPY has had an average daily total return of 0.042% and an average daily total return standard deviation of 1.163%. I use daily returns (rather than monthly returns or annual returns) because this increases the sample size under consideration.

In reality, stock market returns do not perfectly fit the normal distribution; but it is a close enough proxy for the purpose of this analysis.

R was used to run a 1000-trial Monte Carlo simulation for each time horizon-savings rate pair. The R script that I’ve used to create the simulation is a variation of the Sure Dividend Retirement Calculator. You can see the modified script here.

I’ll also be assuming — for simplicity’s sake — that the person who is doing the investing has an annual income of $70,000 per year. This analysis would yield the same results for any other assumed income; but some level of income must be selected to compute the dollar value of invested capital given a particular savings rate.

The last assumption I’ll make is about dividend yield. The S&P 500 Index ETF currently has a dividend yield of about 1.9%.

This is certain to change over time; however, I have about as much information on what the S&P 500 yield will be in 15–45 years as I do about the weather in 15–45 years. In other words, I’m clueless.

One thing is certain: the S&P 500’s dividend yield is currently much lower than its normal historical levels:

Source: Multpl

This means that using its current 1.9% dividend yield as a proxy for future dividend income is conservative. Thus, 1.9% will be the rate used to determine dividend income once final portfolio values are computed using the Monte Carlo simulator.

The Simulation Results

Here are the retirement portfolio value after investing in the S&P 500 over various time horizons and savings rates using a $70,000 income for simplicity’s sake.

While this table is interesting, we do not care so much about portfolio size.

What we are really concerned about is our portfolio’s ability to generate retirement income.

The following table shows the retirement income generated from each of the portfolio sizes in the previous table, using the S&P 500’s current dividend yield of 1.9%. Cells highlighted in green are sufficient to replicate the investor’s annual employment income using dividends alone.

To generalize this, we can show — as a percent — the individual’s ability to replicate their day job income using dividend payments:

The retiree was unable to cover their retirement expenses using dividend payments in more than half of the situations I investigated. Importantly, there was no time horizon where a 10% savings rate was sufficient to retire on dividends alone.

So how can we make this easier?

There are a number of ways an investor can improve their chances. Aside from the obvious (starting earlier or increasing their savings rate), the retired investor can also invest in a high-yield dividend ETF (rather than the S&P 500 ETF).

One notable example is the Vanguard High Dividend Yield ETF, which trades under the ticker VYM. The ETF has a current dividend yield of 2.9%, significantly highly than SPY’s.

If an investor held SPY until retirement and then switched to VYM, the percentage of their employment income covered by dividend payments becomes far superior:

Under this scenario, an investor with a 30% savings rate and 30 year time horizon now has the potential to cover their living expenses with dividend payments. Moreover, a very long-term investor (45 year time horizon) with a 10% savings rate can now retire on dividends.

Importantly, there doesn’t appear to be any additional risks in this strategy; VYM has had almost exactly the same volatility as SPY since the inception of each ETF.

Investors who need even more yield can look for other investment options that offer the prospect of higher dividend income.

Final Thoughts

This article showed the impressive power of dividend growth stocks for long-term wealth creation.

With a sufficient savings rate and time horizon, investors stand a good chance of covering their entire living expenses on dividend payments alone.

For the scenarios where dividends were not sufficient, the outlook is not necessarily bleak. It is alright to draw down some principal during retirement if you do not intend to pass on your full wealth to your heirs. Many people enjoy long and prosperous retirements by periodically selling some of their stock holdings.

With that said, the best case scenario is to retire on dividends alone. This article showed that this is a distinct possibility using a long-term dividend growth investing strategy.

Retiring Off Dividends: What Are the Odds? was originally published in Of Dollars And Data on Medium, where people are continuing the conversation by highlighting and responding to this story.

Turn Off, Tune Out, Get Rich

Mar, 08/01/2017 - 13:01
Why Ignoring Financial Noise is Crucial For Investment SuccessPhoto: Flickr

This week I want to talk about the amount of noise that exists in the financial media and how you would be far better off as an investor if you ignored it. The idea here is that by consuming financial media you are going to be more susceptible to psychological changes that harm your long term investment returns. In others words, you will panic and you will sell.

To start this discussion, I am going to bring forth the analogy of Mr. Market, a metaphorical figure created by the legendary value investor Benjamin Graham. Paraphrased from Graham’s book, The Intelligent Investor:

Imagine that in some private business you own a share that cost you $1,000. One of your partners, named Mr. Market, tells you what he thinks your share is worth and furthermore offers either to buy out or to sell you an additional share on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or fears run away with him, and the value he proposes seems to you a little short of silly.Will you let Mr. Market’s daily communication determine your view of the value of your $1,000 share in the enterprise?

You face the same predicament as the one above EVERY. SINGLE. DAY. while you are invested in the stock market. Throughout the week you are constantly being presented with a price and have to decide whether to buy shares, sell shares, or hold on to what you have.

The problem with the market, and financial media generally, is the amount of noise that comes out on a daily basis. I cannot tell you how many times I have seen a headline like, “Stocks up/down after [insert event here].” Almost all of these events will have little to no impact on the trends underlying the stock market’s long term growth, yet long term growth prospects are nowhere to be found in the reporting. It gets even more entertaining when a news outlet explains why stocks are “up” in the morning to then later point out why they are “down” in the afternoon. And sometimes these market shifts are explained using the same event.

What I have come to realize is that the financial media isn’t really for investors, but for traders. The financial outlets won’t tell you that though. Noise means something to a trader, but to an investor it should be promptly ignored. It is understandable why the financial media behaves this way though. They need to create this sense of dread for their viewers to keep reading and watching. It is better for their business model. More eyeballs = more ad $$.

If I had my own investing show it would last all of 20 minutes one time. In those 20 minutes I could provide the core principles that would guide you through most of your investment life. For everything else more personal/complex, see a financial planner.

With that being said, rather than just talking about noise in the financial markets, let’s look at some data. Using 1-year real U.S. stock and bond returns, the noise in the market looks something like this:

Over 1 year periods, markets can be very chaotic for both U.S. bonds and U.S. stocks. This is also true over shorter time horizons (i.e. monthly, daily, intra-day, etc.). However, the chaos fades as the time horizon increases. Below is an animation I created that shows the S&P 500 and U.S. 10-year Bond returns as they vary from a 1-year horizon to a 30-year horizon. What you will notice is that over longer time horizons, the trends of society play out and all of the noise falls away. Start watching at the “1-Year Period” chart and you will see this process in action:

As the return period increases, we are witnessing changes in productivity, technology, business organization, and much more. These are the true drivers of wealth creation and the things that one should focus on as an investor. As I have stated previously, there are always many reasons to sell. There will always be noise implying that you should get out, that this time it’s different, and that the world will really end. However, it probably won’t.

Escape the Quicksand

Watching financial news is akin to being caught in quicksand. The more you watch, the more likely you are to react to short term events and do something that could lose you money. Remember, you only lose money when you sell. And you are more likely to sell during a panic when a news outlet is flashing turmoil across your screen. This is not an analytical argument, but a psychological one. Even Sir Isaac Newton lost a small fortune in the South Sea Bubble of 1720, despite being one of the smartest people to ever live. Newton later remarked something along the lines of:

I can calculate the motion of heavenly bodies, but not the madness of men.

So turn off, tune out, and get rich. Don’t consume too much financial media (including this blog). When it comes to investing, Jack Bogle, the founder of Vanguard, gave some of the best advice I have ever heard:

Don’t just do something, stand there!

Thank you for reading!

➤ If you liked this post, please consider clicking the ❤️ below or sharing on Twitter, Facebook, or LinkedIn.

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This is post 33. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data

Disclaimer

The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. The postings on this site are my own and do not necessarily reflect the views of my employer. Please read my “About” page for more information.

OfDollarsAndData.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com and affiliated sites.

Turn Off, Tune Out, Get Rich was originally published in Of Dollars And Data on Medium, where people are continuing the conversation by highlighting and responding to this story.

Ignore the Price, Remember the Dividends

Mar, 07/25/2017 - 13:39
Why Dividends Are The Key To Building WealthPhoto: Pixabay

This week’s post can be found at SureDividend.com as a guest post:

http://www.suredividend.com/ignore-price-remember-dividends/

➤ If you liked this post, please consider clicking the ❤️ below or sharing on Twitter, Facebook, or LinkedIn.

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This is post 32. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data

Disclaimer

The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. The postings on this site are my own and do not necessarily reflect the views of my employer. Please read my “About” page for more information.

OfDollarsAndData.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com and affiliated sites.

Ignore the Price, Remember the Dividends was originally published in Of Dollars And Data on Medium, where people are continuing the conversation by highlighting and responding to this story.

Against the Gods

Mar, 07/18/2017 - 12:54
How to Think About Risk in Your Personal FinancesPhoto: Pixabay

This week I want to discuss a book I read recently called Against the Gods: The Remarkable Story of Risk by Peter L. Bernstein. Besides Bernstein’s incredible writing style and memorable anecdotes, the book fundamentally changed how I viewed risk with regards to my personal finances. My goal with this post is to highlight the main idea of Bernstein’s book and provide a simplified framework for thinking about risk and your money. To start, let’s take a very brief tour on the history of risk in human society.

Until the mid 1650s, human societies viewed uncertainty and risk with something destined from on high. For example, during a recent visit to the ancient Mayan city of Tulum I was told that the Mayans worshipped many different Gods, each of whom controlled a particular aspect of the universe. If a Mayan farmer needed rain, they would provide an offering to a rain God. If they needed to go to war, they would go to their war deity, and so forth. Chance was outside of the realm of humans and left up to the Gods.

This idea was not unique to the Mayans. Almost universally human societies have, at some point, believed in a God (or Gods) to ask for help or guidance. It was only within the last few hundred years that this relationship changed and humans decided to go against the Gods and learn the rules of chance. Alas, the title of Bernstein’s book and this post. While humans have made a lot of progress since ancient times, we are still not great at thinking about risk, especially in terms of personal finances. So, let’s address and simplify risk.

One definition of risk is the chance of losing money. This is a useful definition, but it misses two important components: time and your expected future liabilities. We will need to address these before we can come to a fuller understanding of risk.

Time

To start this discussion, let’s consider a quote from Bernstein:

Risk and time are opposite sides of the same coin, for if there were no tomorrow there would be no risk. Time transforms risk, and the nature of risk is shaped by the time horizon: the future is the playing field.

Any definition of risk must contain a time horizon or it is incomplete. For example, the S&P 500 is typically more volatile over a 1 year period than any long term U.S. Treasury bond, but over any historical 30 year period, the S&P 500 is far less risky. Why? Over all 30 year periods for which we have data, the S&P 500 has outperformed U.S. 10-Year Treasury bonds:

It is not necessarily true that this will hold in the future, but the time horizon changes how you perceive and experience risk. The more time you have, the less risk you bear.

Expected Future Liabilities

Every individual has different personal finances and expected future liabilities. Some people want kids, others want a fancy house, etc. Your personal financial situation is incredibly important regarding risk, but can be glossed over when discussing whether an investment is risky. For example, while one investment may be risky for me, it may not be for you, simply because we have different future expected liabilities. Bernstein’s cites a brilliant quote from Robert Jeffrey, a family trust manager, that summarizes this concept well:

The real risk in holding a portfolio is that it might not provide its owner, either during the interim or at some terminal date or both, with the cash he requires to make essential outlays.

If you need to spend money and you can’t, that’s risk.

Putting these concepts together, I have created an equation for how you can think about YOUR ability to take risk throughout life:

Ability to Take Risk = Assets - Liabilities + Time

Your ability to take risk is equal to your assets minus your expected future liabilities plus the amount of time you have. Having more assets, fewer future liabilities, and more time all increase your ability to take risk. You can’t control the amount of time you have, however, time provides the opportunity to recoup losses, so more is better.

The two things you can control in this equation are your assets and your liabilities. The more assets you have (hopefully liquid ones that are also diversified), the more cushion you have to survive financial shocks, and the more risk you can take. This is also true with fewer expected future liabilities. If you need to spend less money in the future, then you can stomach more risk in the present. Therefore, you can control your risk taking ability by adjusting your spending and saving accordingly.

This equation does have its pitfalls though. It doesn’t control for individual investor preferences (i.e. you may want far less risk than you could reasonably put up with), and it doesn’t take into account whether your asset values are inflated or undiversified. In a bubble, this equation would suggest you could take on more risk when, in reality, you would want to be taking less risk. Your inflated asset values would give you the wrong idea about your true risk tolerance. Proper diversification should mitigate this issue though.

Risk is in the Eye of the Beholder

No matter what stage you are at in your financial life, risk will always be relative to your personal situation. As your situation changes, your ability to take risk will change, and so will your preferences for taking risk. I wish I could give you a silver bullet solution for understanding how much risk you can endure, but this isn’t possible. There are too many individual factors that contribute to risk in your financial life (i.e. seek out a financial planner). What I can tell you definitively is that you can control your ability to take risk by adjusting how you save and spend money. If your financial life seems too risky, consult the equation above and pull the appropriate lever until you have peace of mind. Remember, risk is in the eye of the beholder.

Though humanity has gone against the Gods to try and unravel the mysteries behind risk, we really aren’t that different from our ancestors. Many of us, myself included, still have superstitions and beliefs in some random force that influences our lives. Even for those that don’t believe in a higher power, I wonder how long it would take for them to find faith during a plane crash. Believing in God, Gods, or some force is a uniquely human trait that is likely here to stay. So the next time you think about risk and your money, realize that you have some control in the situation. Then again, if the Gods favor you, you wouldn’t need to worry about risk…right?

Thank you for reading!

➤ If you liked this post, please consider clicking the ❤️ below or sharing on Twitter, Facebook, or LinkedIn.

➤ You can follow Of Dollars And Data via Email (1 weekly newsletter), Facebook, Twitter, or Medium.

This is post 31. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data

Disclaimer

The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. The postings on this site are my own and do not necessarily reflect the views of my employer. Please read my “About” page for more information.

OfDollarsAndData.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com and affiliated sites.

Against the Gods was originally published in Of Dollars And Data on Medium, where people are continuing the conversation by highlighting and responding to this story.

Wanna Get Rich? Think Fractally

Mar, 07/11/2017 - 13:00
On the Fractal Nature of Compound InterestPhoto: The Sierpinski Triangle

This week I want to talk about compound interest, fractals, and how you can use them to make yourself rich. Before we get into the compound interest part of things, let’s first take a dive into fractals.

A fractal is a geometric object that displays symmetry at different scales (or levels of magnification). Therefore, if you were to visually zoom in on a fractal, you would see a pattern that was similar to the original (larger) object. The Sierpinski Triangle above is one of the most straightforward ways to explain fractals as the outside triangular pattern repeats infinitely within itself.

The thing about fractals is that they are found almost everywhere in nature. Trees, coastlines, veins, and many other natural objects display fractal properties. One of my favorite fractals is Romanesco Broccoli:

Photo: Romanesco BroccoliSo, you might be wondering:How can fractals make me rich?

Fractals themselves will not do anything for you, but understanding compound interest and how it behaves fractally can make you rich. To get started let’s consider a thought experiment.

Let’s say you decide to invest $100 and you have the ability to get a 10% annual rate of return. At the end of 1 year you will have your $100 in principal and an additional $10 in interest. Nothing special. However, as you continue to compound your money, the process starts to behave fractally. How? In year 2, when your $100 once again gives you $10 in interest, now your $10 in interest from year 1 will throw off $1 in interest as well. The $10 has begun to behave like the $100 did in year 1. You can imagine the relationship between the $10 and its $1 in interest like the $100 and its $10 in interest. And this process continues in year 3 when the $1 in interest from year 2 throws off $0.10 in interest, and so on.

The beauty of compound interest is that it continues to behave fractally with each piece of interest eventually earning its own interest. Money begets money and you get rich. To visualize this, consider the following graphic I put together to illustrate the fractal nature of compound interest. Note that I used a 50% annual return to make this easier to visualize, but the effect is the same. What you will notice in the graphic below is that as the years progress, the original principal of $100 (green bar) earns interest (red bar) each year. In addition, the interest from year 1 (red bar) starts generating interest in year 2 (blue bar). And finally, the interest from year 2 (blue bar) will generate interest in year 3 (black bar):

What’s amazing about this process is how it starts to grow so quickly. I only did this over 3 periods, but if I continued to expand it, the visualization would get very large in no time. If you are still missing how this is fractal, consider the relationship in year 1 between the green and red bar. This relationship also appears in year 2 between the red and blue bars (on a smaller scale). And the process repeats itself in year 3, etc.

If you are still skeptical of the power of fractals, consider the following: It is alleged that Albert Einstein was asked what is the most powerful force in the universe and he replied: “Compound interest.”

The True Power of Fractals

The true power of fractals lies in the fact that their complexity comes from a few simple actions done over and over again. This is the power and beauty of nature. A clump of cells, with enough division, becomes a human being. This is also true for your financial life. By doing a few simple actions over and over again, you will ensure your path to wealth. Think about it: save, invest, rebalance periodically and you are set. This is why my most popular post is still Just Keep Buying. One simple action done many times leads to powerful results.

That aside, I want to leave you with a great story about the inventor of the fractal, Benoit B. Mandlebrot. Mandlebrot is responsible for the most famous fractal of all time, the Mandlebrot set, which he first visualized using computers in the late 1970s. In addition, in The Misbehavior of Financial Markets, Mandlebrot wrote a scathing critique of financial markets and their reliance on the normal distribution for pricing securities. However, the most amazing example of his brilliance was his middle name. Though there is no record suggesting he had a middle name at birth, he decided to adopt the middle initial of “B.” at some point in life. No one knows what the “B.” stood for, but theories suggest that it stood for “Benoit B. Mandlebrot.” Yes, even his name was fractal. If you are interested in learning more about fractals, check out The Fractal Geometry of Nature by Mandlebrot. Thank you for reading!

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This is post 30. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data

Disclaimer

The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. The postings on this site are my own and do not necessarily reflect the views of my employer. Please read my “About” page for more information.

OfDollarsAndData.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com and affiliated sites.

Wanna Get Rich? Think Fractally was originally published in Of Dollars And Data on Medium, where people are continuing the conversation by highlighting and responding to this story.

E Pluribus Unum, Among Many…One

Mar, 07/04/2017 - 12:57
On the American Stock Market and its FuturePhoto: Pixabay

Given it is July 4th, I thought it would only be fitting to talk about the one and only United States of America. In particular, I want to talk about how the U.S. became the dominant stock market of the 20th century and why the 21st century still looks promising for American businesses.

To start, let’s look at some data on the share of world stock market capitalization represented by various regions of the world in the year 1900 (data was taken from this Investopedia article):

As you can see, the U.S. represented 22% of the global equity market at the beginning of the 20th century. During this time European countries acted as large competitors to the U.S., however, over the course of the 1900s this changed drastically. By the year 2000, the U.S. had a 47% share of global equity markets:

What you will notice, besides the increase in the equity market share of the U.S. and Japan, is the much smaller role that Europe plays in global stock markets by the year 2000. This result does not necessarily surprise me though. Considering the fact that Europe was ravaged by 2 wars in the first half of the 20th century, it doesn’t seem remarkable to me that the U.S. would expand its market presence. For example, it was estimated that one quarter of all Russian capital resources were destroyed in WWII. Do you know how insane that sounds? I can’t even imagine a similar scale event happening in the U.S.

Despite the increased market share that the U.S. commanded at the beginning of the 21st century, let’s consider the U.S. stock market performance from 1900–1999. If you had invested $1 in the U.S. stock market in January 1900 and reinvested your dividends, by January 2000 you would have had $1,000 (after inflation, but before transaction costs). Looking at the plot below you can see the U.S. real stock market return with dividends for the 20th century (January 1900 — December 1999) and the 21st century (January 2000 — December 2016) overlaid on the same plot (Note: the log scale on the y-axis):

As you can see, the differences between the centuries are close to converging at this point (i.e. 16 years in). This does not imply that the U.S. stock market will have the same magnificent performance in the 21st century as it did in the 20th century, however, consider the following thought experiment:

From 1900–1999 the U.S. stock market produced a real return of ~ 7.15% a year. This is the 1000x total increase pictured above. If we assume 1% annual transaction costs (i.e. a 6.15% real return), you would have gotten a 390x cumulative increase over this period. Now, consider the 21st century. As of the end of 2016, we had only experienced a 1.5x cumulative increase(i.e. $1 has turned into $1.50 in real terms). Even if the 21st century only produces a 4% average real return, this means that we should expect a 50x cumulative increase (i.e. $1 becomes $50) by the year 2100.

Consider that idea for a moment. Even if the 21st century is only 2/3rds as fruitful as the 20th century, the U.S. stock market will still do quite well and you can be quite wealthy. While I (nor anyone else) can guarantee the future success of the U.S. stock market, I think there are still some major advantages that make the 21st century seem promising.

Risk Taking and the Future of U.S. Stock Returns

While the U.S. has outperformed global stock markets in the last few months, over longer time horizons global stock markets have been remarkably similar in performance terms (chart from this Bogleheads page):

Source: Bogleheads.org

There is nothing that states this has to be true going forward. However, if we assume some level of stability in the future (i.e. no world wars), I would expect most equity returns to be similar across most developed regions over time. This is becoming even more true in today’s world with an increasing focus on global markets.

Despite my belief in the converge of equity returns, I still think the U.S. has the best game in town because of its culture of risk taking (especially in Silicon Valley) that allows for massive value creation. Experimentation in business and technical pursuits seems to be America’s edge in the global economy. If you combine this with America’s ability to attract top talent from across the globe, the edge gets even stronger.

So, where will the U.S. stock market end up in 2100? No one knows, but as Warren Buffet has stated:

It has never paid to bet against America. We come through things, but it is not always a smooth ride.

Happy 4th of July. Thank you for reading and God Bless the United States of America!

➤ If you liked this post, please consider clicking the ❤️ below or sharing on Twitter, Facebook, or LinkedIn.

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This is post 29. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data

Disclaimer

The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. The postings on this site are my own and do not necessarily reflect the views of my employer. Please read my “About” page for more information.

OfDollarsAndData.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com and affiliated sites.

E Pluribus Unum, Among Many…One was originally published in Of Dollars And Data on Medium, where people are continuing the conversation by highlighting and responding to this story.

Free Yourself from Your Investments

Mar, 06/27/2017 - 13:02
On the Psychology of Picking Stocks and How to Use Passive Investing to Your AdvantagePhoto: Pixabay

Do you think you can predict the future? I am guessing you, like me, would confidently say no. But, what if I asked you to predict the future of a very specific thing? Say the future of a company (i.e. Snapchat, Uber, etc.) or a product? Now it doesn’t seem as far fetched to make a prediction, does it? And if I asked you whether you were better than the average person at making these specific predictions, I am guessing you might say yes.

Just think about it. You are decent at making predictions, aren’t you? Think of all of the times you saw something and you knew it was going to be a hit? I bet right now you can name at least a few things that you were completely right about before they became foregone conclusions. For example, I remember seeing Youtube when I was in high school in 2006 and I knew it was going to be the biggest thing ever. I told my friends, but they were skeptical.

Making predictions is fundamental to human societies. From forecasting weather patterns to trying to anticipate the next billion dollar startup, we have a tendency to try and imagine what the future holds. However, when it comes to investing, making predictions is more likely to harm you than help you. And this goes beyond the simple argument that stock picking is harmful because you are likely to underperform an index fund/ETF. Yes that is true, but that argument misses a much larger behavioral component as to why passive investing is better for you and most other investors:

Passive investing frees you from the psychological impact of identifying with your investments.

Think of it this way: If you put a sizable portion of your net worth into individual stocks, and those stocks underperform the market, this would challenge your identity. You might start to think that you were a loser because you made a choice that lost you money. This explains why investors tend to sell their winners and hold their losers for far too long. They are hoping that the losing stocks will rebound so that they will be vindicated as good active investors.

Personally, I regret the few active investments I have made historically not because of my slight underperformance relative to the market, but because of the psychological effects it had on me. I still remember having 2% of my net worth in a tech stock and checking it like mad throughout the day. EVERY. SINGLE. DAY. However, I never batted an eye when my passive investments (the other 98%) fluctuated on a daily basis and gained or lost far more money than that one tech stock. The passive investments didn’t define me in the same way as my 1 active stock pick. I wasn’t any more of a winner or loser when my ETFs changed in price, because investing in broad based indices like the S&P 500 didn’t feel like making a prediction.

Michael Batnick has an incredible post where he describes something he calls the “satisfaction yield”, which exemplifies the idea of an investment identity. In his post he describes 2 different investments scenarios with the same starting and ending value, but with very different paths getting there. “Investment 1” has an initial fall and recovery while “Investment 2” has a large initial appreciation and a subsequent decline:

Source: The Irrelevant Investor

If you are an investor in “Investment 1” you probably feel like a hero. You might as well have saved a kitten from a burning building. However, if you are an investor in “Investment 2” you probably feel like a loser for not selling earlier when you knew that you should have. From a purely rational perspective, you should be okay with either investment, but your investment identity would feel better with Investment 1.

My argument here is to abandon your investment identity altogether. Go passive and do more important things with you life. All the time you will spend researching and worrying about your active investments is not worth it. Spend that time doing something more valuable. Remember that investing is easy, if you allow yourself to make it easy.

Take the Red Pill

When it comes to prediction, it is easy to recall all of the times we got it right. But what about all the times we got it wrong? For my one Youtube hit, I was completely wrong on Facebook, Snapchat, Uber, and many other companies that I didn’t think had any monetization value. Maybe I am terrible at predicting the future, or maybe most people are and they don’t realize it.

My advice to combat this is simple: free your mind from your investments. Go passive and just keep buying. Continue to average in and you will not be disappointed. I have had friends tell me how liberating this mindset is for investing. It has worked well for me so far and I am just getting started. As always, thank you for reading!

➤ If you liked this post, please consider clicking the ❤️ below or sharing on Twitter, Facebook, or LinkedIn.

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This is post 28. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data

Disclaimer

The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. The postings on this site are my own and do not necessarily reflect the views of my employer. Please read my “About” page for more information.

OfDollarsAndData.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com and affiliated sites.

Free Yourself from Your Investments was originally published in Of Dollars And Data on Medium, where people are continuing the conversation by highlighting and responding to this story.

Bitcoin and the Power of Belief

Mar, 06/20/2017 - 13:04
Why Cryptocurrencies are No Different From Most Other Risky AssetsPhoto: Pixabay

In the past few weeks, a few things have happened that have led me to do some digging on Bitcoin and why I think it is not that different from most other risky assets. For those of you that do not know what Bitcoin is, it is a digital currency that can be used to make peer to peer payments without an intermediary (i.e. a bank). Bitcoins have no central backer and rely on a decentralized network of record keepers that work off of the same ledger of transactions (called the “blockchain”). The idea of the blockchain is to record all transactions and share this information with the Bitcoin network without having to rely on one entity to verify or control the currency.

The interesting thing about Bitcoin is that there is a fixed supply of Bitcoins that can ever be “mined.” Without getting into the details, Bitcoins can be mined by having computers perform increasingly complex calculations. Currently, there are over 16 million Bitcoins in existence (with a market cap of about $40 billion), but the theoretical limit for total number of Bitcoins is 21 million, which we are predicted to reach by 2140.

This matters to you as an investor, because a cryptocurrency, like Bitcoin, may one day replace the U.S. dollar as the reserve currency of the world. I think this is unlikely to happen soon, but if we get closer to this possibility, the value of Bitcoin will soar. This is the fundamental relationship behind all currency valuations: belief. As more people believe in Bitcoin as a legitimate currency, the value goes up, and as less people believe in it, the value will go down.

To start with some context, Bitcoin has been on a wild ride upward this year:

While this may look enticing, you have to realize that getting to this point was not easy. Below is an animation showing the drawdowns (i.e. declines from peaks) in Bitcoin over time. To make this feel more real, imagine owning Bitcoin in late 2010 and watching the value of it drop by over 50% on more than 4 occasions. Though this would have been difficult to endure, you would have been rewarded handsomely had you held on:

This brings me to my main point: How is Bitcoin’s behavior as an asset that much different than any other risky asset (i.e. individual stock)? Yes, it is probably more volatile than an individual stock, but it’s not like individual stocks are a picnic either. I have already shown how successful stocks can experience large drawdowns over time:

So why do some investors shun Bitcoin and cryptocurrencies? They may call it speculative, but I see it as no more speculative than buying an individual company’s stock. You might counter argue that a company produces income while Bitcoin does not. I see that point, but I would argue that belief is as fundamental to a company’s continued income as it is to Bitcoin’s increase network of users. Is it any more far-fetched to believe that a company’s income is going to grow at X% a year for 10 years than to believe that Bitcoin could continue to increase its user base? I have created valuation models during my career and those models are as prone to beliefs and assumptions as anything else.

For example, most of the value of most tech companies comes from expected cashflows that can be decades in the future. I have a friend who works at Uber who told me that Uber’s entire future is basically a long term self-driving car play. Just like Bitcoin, most risky assets require some form of belief.

Belief is What Makes Us Human

In the end, it is not beliefs that matter, but what actually happens in the real world. Whether an earnings report is released for a company or a cryptocurrency is adopted as a store of value, information eventually comes out that corrects our collective beliefs. Despite the fact that not all beliefs are equally valid, the act of believing is what makes us human.

I recently started reading Sapiens: A Brief History of Humankind by Yuval Noah Harari, and one of Harari’s key insights focuses on the power of belief:

Telling effective stories is not easy. The difficulty lies not in telling the story, but in convincing everyone else to believe it. Much of history revolves around this question: how does one convince millions of people to believe particular stories about gods, nations, or limited liability companies?

How different is it to believe in Bitcoin over believing in the U.S. government? How about the success of an individual company? The only difference I see is the number of current believers. Thank you for reading.

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This is post 27. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data

Disclaimer

The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. The postings on this site are my own and do not necessarily reflect the views of my employer. Please read my “About” page for more information.

OfDollarsAndData.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com and affiliated sites.

Bitcoin and the Power of Belief was originally published in Of Dollars And Data on Medium, where people are continuing the conversation by highlighting and responding to this story.

Strike While the Iron is Hot

Mar, 06/13/2017 - 13:05
The Role of Momentum and Timing in the Stock MarketPhoto: Pixabay

This week I want to talk about market timing and momentum in stock prices. Though I have already described why you should just keep buying regardless of market valuations, I want to dig deeper on this point to illustrate how difficult it can be to time the market and why buying at all time highs is not always a thing to be avoided.

To start, I want to tell you about a simulation I ran to test whether it would be possible to time the market (i.e. buy low and sell high) based on the market’s valuation. In particular, I used Robert Shiller’s S&P 500 real price/dividend data and his cyclically adjusted price to earnings ratio (CAPE) as my valuation measure. My goal was to use the CAPE to determine when to buy and sell stocks. I tested a buy low/sell high strategy with various low and high CAPE values. For example, one of the many strategies I tested was:

  • Buy when CAPE goes below 15 (i.e. stocks are cheap) and sell when it goes above 30 (i.e. stocks are expensive). After you sell, don’t buy again until the CAPE is below 15.

Unfortunately, I discovered that there was no consistent strategy that outperformed buy and hold over all market periods observed. In some periods a market timing strategy (like the one mentioned above) outperformed buy and hold, but in other periods it failed. For example, using the “buy at CAPE = 15, sell at CAPE = 30” strategy would have been successful in the years before the Great Depression, but it would have failed miserably during the dotcom boom of the late 1990s. Others have come to similar conclusions about using CAPE for timing the market.

While my simulation does not disprove market timing as a whole, since there are many timing strategies that are more complex than this, it does illustrate that you cannot time the market purely based on the market’s valuation. However, this begs a bigger question: What about buying near all time highs? CAPE hitting 30 may not mean anything, but maybe buying near an all time high may be indicative when to exit the market, right?

To address this, let’s consider the real monthly returns (including dividends) of the S&P 500 from 1880–2016. Below is an animation that shows this price series over time with a red dot for every time the S&P 500 reached a new all time high. Of the 1,644 monthly returns in the data, 356 were all time highs, which represents ~22% of all months. Note that I use a log scale for the y-axis:

As you can see, the S&P 500 has periods of what I call “fits and starts”, or lackluster growth and then explosive growth. Michael Batnick, who runs the Irrelevant Investor, summarized the relationship between fits and starts of the S&P 500 beautifully with the following chart:

Source: The Irrelevant Investor

As you can see, some periods produce gains that are 10x larger than other periods of time.

Despite these fits and starts, there is an interesting relationship between all time highs in the stock market. Once you have hit an all time high, the very next month you are likely to hit another all time high. To be exact, of the 356 market peaks, ~67% of them were followed by another market peak in the next month and ~90% of them were followed by another market peak within the next 4 months.

Market peaks cannot go on forever, which is why there can be long periods of drawdowns before a new peak is reached. However, this underscores the important role that momentum plays in the stock market. If we were to plot the number of months between market peaks it would look like this:

Though this chart may suggest that market peaks usually happen far apart from each other, these long periods are the exception. Most of the action is happening near the base of the y-axis where the number of months between peaks is low.

Don’t Be Afraid to Keep Buying

I understand that buying at an all time high doesn’t feel right because of the history of market crashes that have followed in numerous cases. I am here to tell you that you should just keep buying. This will only work for a limited time, but missing the upside could be more devastating to your portfolio than experiencing the downside.

One caveat with this analysis is that some markets reach all time highs and then never get back to those all time highs (i.e. we are still waiting for Japan to surpass its 1989 peak). This is a legitimate risk, but if you are following some form of dollar cost averaging, you will reduce the impact of these kinds of events. Stay the course and don’t fear the bull (or the bear that will follow). Thank you for reading!

➤ If you liked this post, please consider clicking the ❤️ below or sharing on Twitter, Facebook, or LinkedIn.

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This is post 26. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data

Disclaimer

The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. The postings on this site are my own and do not necessarily reflect the views of my employer. Please read my “About” page for more information.

OfDollarsAndData.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com and affiliated sites.

Strike While the Iron is Hot was originally published in Of Dollars And Data on Medium, where people are continuing the conversation by highlighting and responding to this story.

Having Water in the Desert

Mar, 06/06/2017 - 12:52
A Lesson From Warren Buffett on the Power of LiquidityPhoto: Pixabay

This week I want to illustrate how you can ensure your financial soundness during the next crisis by having ample liquidity. But first, let’s start with a story:

“But everything was not fine. Long-Term, which had calculated with such mathematical certainty that it was unlikely to lose more than $35 million on any single day, had just dropped $553 million — 15 percent of its capital — on that one Friday in August 1998. It had started the year with $4.67 billion. Suddenly, it was down to $2.9 billion. Since April, it had lost more than a third of its equity.”

-When Genius Failed: The Rise and Fall of Long Term Capital Management, Roger Lowenstein

The above passage illustrates the beginning of one of the greatest downfalls in hedge fund history — the fall of Long Term Capital Management (LTCM). Despite the spectacular downfall, it was how Warren Buffett responded to the situation that can teach us an important lesson about the power of liquidity.

Before we continue that story, let’s quickly define liquidity so we are all on the same page. Liquidity is a measure of how quickly an asset can be bought or sold without altering the asset’s price. Most of the time, most markets are highly liquid and assets can be bought and sold without issue. However, during a panic, buyers flee, prices plummet, and liquid assets quickly become illiquid. Therefore, having liquidity as an investor means to hold assets that can be easily sold at stable prices.

In the case of LTCM’s decline, their bets on bond spreads became highly illiquid and they continued to lose money as buyers were nowhere to be found. LTCM’s partners realized that they needed cash reserves to hold them over until the financial panic had passed and liquidity resumed. Enter Warren Buffett.

How does Buffett get involved in this fiasco? A few of the bankers involved in helping LTCM contact Buffett because they know he has something that no one else has: money.

In particular, Buffett agrees that he can front LTCM the $3 billion in capital they require to survive the financial storm, but for a price. Buffett wants all of LTCM’s assets for $250 million. Yes, the same assets that were once worth ~$4.67 billion now have an offer price of $250 million. At the time of Buffett’s proposal, LTCM had roughly $555 million in equity remaining, but Buffett’s offer stood at $250 million.

Though Buffett’s deal did not go through due to a legal technicality, it likely would have. This illustrates the power of liquidity during market downturns. When everyone is panicking and no one is willing to buy, a buyer can dictate incredibly low prices.

The funny thing is that Warren Buffett does this all of the time. He has a track record of buying companies or lending money when the investment environment looked darkest. For example, Buffett famously aided Goldman Sachs during the financial crisis when he supplied them with cash for shares of Goldman’s stock. Buffett’s final profit ended up being over $15 a second over a 5 year investment period! Looking at Berkshire Hathaway’s cash position during the financial crisis, we see a sharp decrease in cash holdings as Buffett buys in (the chart is from this article):

This demonstrates how Buffett uses his liquidity when the right opportunity presents itself (i.e. sellers become desperate).

Despite his folksy charm, Buffett remains a full-fledged capitalist who wants a cheap deal. Buffett summarizes this part of his investment philosophy beautifully with a quote about baseball:

The stock market is a no-called-strike game. You don’t have to swing at everything — you can wait for your pitch.

And that’s what he does. He waits and waits for the right pitch. Fun fact: Berkshire’s current cash position is the highest it has ever been at $96.5 billion, as of March 31, 2017.

How You Can Use Liquidity To Your Advantage

Though you will likely never have Warren Buffett’s level of liquidity or his business experience to time market purchases, you still can use liquidity to your advantage during future panics. To do this, you should not view liquidity as a way to buy more assets at low prices, but as a way to prevent yourself from selling your assets at depressed prices. While it is tempting to only buy during downturns, if your economic conditions worsen, you could end up having to sell those risky assets you bought at even lower prices. In other words:

Don’t play to win, play not to lose.

For the average investor, the purpose of having ample liquidity (i.e. riskless assets like short term bonds/cash) is to provide you with stability in case of job loss or another financial shock. You may experience prolonged financial distress, and liquidity is the only way to prevent you from raiding your 401(k) or other investment accounts. The last thing you want is to sell assets at a steep loss.

As for the right amount of liquidity to have, no one knows. Some say 6 months as an emergency fund, but I would shy on the side of more rather than less. When you are in the desert, having more water doesn’t hurt. Lastly, if you want to find out how the Long Term Capital Management story really ends, I highly recommend Lowenstein’s book. Thank you for reading!

➤ If you liked this post, please consider clicking the ❤️ below or sharing on Twitter, Facebook, or LinkedIn.

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This is post 25. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data

Disclaimer

The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. The postings on this site are my own and do not necessarily reflect the views of my employer. Please read my “About” page for more information.

OfDollarsAndData.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com and affiliated sites.

Having Water in the Desert was originally published in Of Dollars And Data on Medium, where people are continuing the conversation by highlighting and responding to this story.

The End is Everything

Mar, 05/30/2017 - 12:59
Why Timing of Investment Returns Matters and What To Do About ItPhoto: Pexels

I have previously written about how luck can influence your investment results, and this post will continue that discussion, but with some additional complexity. Not only does luck matter, but, in particular, your returns right before and in the first years of your retirement will have a disproportionate impact on your investment success. In other words:

The end is everything.

Before I discuss what you can do to mitigate this risk, let’s start with a thought experiment to explain this concept.

Suppose you put $10,000 into an investment account and then you experienced the following returns over the next 4 years: +25% in year 1, +10% in year 2, -10% in year 3, and -25% in year 4.

Would you have been better off if you had gotten the returns in a different order? For example, does -25% in year 1, -10% in year 2, +10% in year 3, +25% in year 4 change your final investment value?

The answer is no.

When using a lump sum (i.e. investing money without adding or subtracting additional funds), the order of your returns do not matter. If you don’t believe me, spend a minute trying to prove how 3 * 2 * 1 is not equal to 1 * 2 * 3.

Now, what happens if you add money to your invested funds over time? Is there a difference between +10%, +25%, -10%, -25% and -25%, -10%, +10%, +25%?

Yes.

When you are adding money over time it is best to have the higher returns at the end, not the beginning, of your investment life.

Why?

You want the highest returns when you have the most money in play. As you add money to your invested funds over time, your risk gets amplified such that a negative return in later years will cost you more in absolute dollar terms than in earlier years. Therefore, downturns early in your investing life can be ideal, as their impact on your final portfolio value are small compared to downturns later in your investment life.

Given you will be acquiring more assets over time, like the vast majority of investors, the timing of your returns matters more than almost any other financial risk you will face. The investment risk I am describing is formally known as sequence of return risk, and is summarized quite well by Michael Kitces in this post.

To visualize sequence of return risk, imagine saving $5,000 a year for 20 years under 2 different scenarios:

  • You receive 10 years of -10% returns, then 10 years of +10% returns. We will call this scenario (“Negative Returns Early”).
  • You receive 10 years of +10% returns, then 10 years of -10% returns. We will call this scenario (“Negative Returns Later”).

Both scenarios have the same geometric and arithmetic average return over the 20 year period, the only difference is the timing of the returns relative to your invested funds. Let’s see how you would end up by looking at the total value of your portfolio under each scenario over time:

As you can see, getting the negative returns later in life, when you have the most money in play, leaves you far worse off than if you experienced those negative returns when you first started investing. If you experience larger negative returns as you approach/enter retirement, your nest egg could be reduced significantly and you might not live long enough to see it bounce back. What makes this scenario worse is that, in retirement, you will be subtracting money from your invested funds. This will deplete your nest egg even faster in the midst of a downturn. However, there are ways to mitigate this risk that I will highlight shortly.

The one positive takeaway from the above plot is that younger investors should not worry about their returns…yet. As I have mentioned previously, younger/poorer investors should focus on their savings and building their skills. This will have a far larger absolute dollar payoff than worrying about your investment returns on smaller sums of money.

How to Prepare for the End Game

When it comes to retirement planning and preparing for the end game, the strategies are complex and highly based on individual preferences and needs. This post would be far too lengthy to cover them all. However, there are a few ways to counteract the effects of a downturn in retirement:

  1. Adequately diversify with enough low risk assets (i.e. bonds). Having a large bond portion (≥50%) as you enter retirement may be able to provide enough income to prevent you from selling equities at depressed prices. In the normal course of rebalancing, you may be able to sell some of your bonds such that you would not need to worry about what happened in the stock market.
  2. Consider withdrawing less money during market downturns. If you had originally planned withdrawing 4% a year, temporarily lowering this to a smaller withdrawal rate would help mitigate the damage done by a market crash (assuming you have to sell assets at depressed prices).
  3. Consider working part time to supplement your income. In the book How To Retire Happy, Wild, and Free, Ernie Zelinski discusses many of the non-financial aspects of retirement including working on something new that could also produce income. I highly recommend the book and believe that work and accomplishment are important for everyone, including retirees.

Thank you for reading!

➤ If you liked this post, please consider clicking the ❤️ below or sharing on Twitter, Facebook, or LinkedIn.

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This is post 24. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data

Disclaimer

The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. The postings on this site are my own and do not necessarily reflect the views of my employer. Please read my “About” page for more information.

OfDollarsAndData.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com and affiliated sites.

The End is Everything was originally published in Of Dollars And Data on Medium, where people are continuing the conversation by highlighting and responding to this story.

Risk and Reward in a New Era

Mar, 05/23/2017 - 13:05
How Investing Has Changed and Why Future Returns Will Likely Be LowerPhoto: Pixabay

This week I want to talk about how much the investing world has changed over the last century and how these changed may reduce your future expected returns. My argument is that because it is now easier, cheaper, and less risky for the average person to invest, a reduction in future returns is warranted. Lower future expected returns will have large implications for investors with longer time horizons (i.e. millennials like myself), however, there are ways to counteract this. In order to explain my thinking, let’s go back to a different time.

Imagine being an average person in 1900–1970 who wanted to invest. During this time, the investment industry had the following qualities:

Less information

Before the advent of the internet, most investors had relatively little access to information. For example, SEC filings weren’t available online until the mid 1990s and there was no Google to find information instantly. In his interview on Masters of Business with Barry Ritholtz, Charles Ellis describes how he used to have to go down to the NYSE to look up company filings and do calculations by hand using a slide rule. This gave a huge natural advantage to those who were in New York and could access this information easily.

If you are still skeptical about the value of information in the past, hear me out. In The Snowball: Warren Buffett and the Business of Life, the author describes how Warren Buffett cut a deal with the local distributor of the Wall Street Journal so that the next day’s paper would be delivered to Buffett’s house around midnight the day before it was released. Therefore, almost every single day for decades, Warren Buffett got the news before almost any other investor. Do you think this had no positive impact on his returns?

Fewer competitors

The number of people that have joined the investment industry in the last few decades is staggering. As Charles Ellis stated in his Masters of Business interview:

“If you go back 50 years, there might have been 5,000 people involved in investing. Now there are at least 1 million people.”Lack of diversification

Though mutual funds were invented in the mid 1920s, most investors did not start using them until the 1980s and 1990s, the same time that fees started increasing. As a chart from this Business Insider article illustrates, mutual funds have increased their total stock market ownership dramatically in the last few decades:

Though I do not have data on the typical number of stocks owned by households in the 1940s–1970s, I would assume that households were not as diversified as a modern index/mutual fund. This means that it seems likely that a larger number of investors have become more diversified in the last few decades.

Does this surprise us? Should we have expected investors in the 1940s–1970s to be diversified when there was little information on the topic? For example, Harry Markowitz, who won the Nobel Prize in Economics for his work on portfolio optimization, did not publicize his ideas until the 1950s, and index funds weren’t created until the 1970s. A Random Walk Down Wall Street, one of the first books to champion index funds, wasn’t published until 1973. Despite the publication, Burton Malkiel, the book’s author, described how hard it was to get people to buy index funds initially:

“Sometimes I used to joke that Jack Bogle and I were about the only people I knew who owned index funds. It was very, very slow to catch on.”Increased risk

Because many investors were not using index/mutual funds, they had to deal with the psychological trauma and increased risk of holding individual stocks. Even owning a handful of individual stocks could not provide the same safety as a diversified index/mutual fund. For example, I have previously cited a paper by Hendrik Bessembinder that illustrates that more than half of all stocks deliver negative lifetime returns and only 42.1% of stocks have a holding period return that exceeds that of one-month T-bills.

The fact is that almost all individuals picking stocks would have experienced higher risk than if they had diversified adequately. However, in the past, diversification was less well understood, it was more expensive to do manually, and there were fewer diversified options available. Cheap index and mutual funds have fundamentally changed all of that, and investors should expect lower returns as a result of taking less risk.

Think of it this way: When you hold the S&P 500 (i.e. in an index fund) you are diversified and have some belief that America as a whole will not fail. However, when it comes to individual companies, the price fluctuations can be more extreme and the fear of failure is real.

To visualize the psychological aspect of this, let’s look at the drawdowns for the S&P 500 and a handful of stocks that have done well historically (Apple, Amazon, GE, Goldman Sachs, and Exxon Mobil):

Besides Exxon (“XOM”), all of the other stocks pictured had drawdowns that were greater than or equal to the S&P 500. This illustrates how even winning stocks can lose enough value (temporarily) that you may doubt your stock picking ability. But this leads me to ask a few questions:

What would you do to avoid this psychological trauma? Would you be willing to give up a few percentage points in expected return to have less risk through diversification?

I would and I am guessing many other investors would as well.

I wish this post was my fully my idea, but it isn’t. I re-framed this idea based on a post by the blogger who goes by Jesse Livermore. His blog post is arguably the most important thing I have read this year because of how much it changed my thinking on the future of investment returns. The post is quite complex, but worth the read if this really interests you. In addition, Ben Carlson and Meb Faber have also discussed how future expected returns in the U.S. should be lower based on current valuations.

What To Do About Lower Future Returns?

If I am completely wrong and U.S. stocks provide 6–8% inflation-adjusted returns over the next few decades (as they have historically), then you and I will be rich and we can laugh about my ignorance over an expensive meal and fine wine. However, if you think I might be right about future returns being lower, this could imply a few things:

Regardless of whether future returns are lower, I would much rather have today’s investing environment than the one of the past. Investing has become so much easier because of indexing and the average investor is far better off as a result. Thank you for reading!

➤ If you liked this post, please consider clicking the ❤️ below or sharing on Twitter, Facebook, or LinkedIn.

➤ You can follow Of Dollars And Data via Email (1 weekly newsletter), Facebook, Twitter, or Medium.

This is post 23. Any and all code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data

Disclaimer

The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. The postings on this site are my own and do not necessarily reflect the views of my employer. Please read my “About” page for more information.

OfDollarsAndData.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com and affiliated sites.

Risk and Reward in a New Era was originally published in Of Dollars And Data on Medium, where people are continuing the conversation by highlighting and responding to this story.