The power of compounding.

snipped-for-privacy@yahoo.com wrote:


Er? Looking at Shiller's data and adjusting for dividends and inflation, it appears I would have gotten almost 9000% return (Jan. 1929 to June 2004).

Er (again)? Same data set (this time starting in Jan. 1905) tells me I would have lost 24% of my total return over the 5 years ending June 2004. Substantial, but not 80%.

If you invested in January 1966 (the high point of the year) you would have been back to even by August of 1967. Perhaps you're thinking of the 70's bear market? Investing in Jan. of '73 (the top) was a harsh reality, not breaking even until Jan. of '85.
Don't forget to check my math, -Will
Add pictures here
<% if( /^image/.test(type) ){ %>
<% } %>
<%-name%>
Add image file
Upload
Will Trice wrote:

No. A 30 year period. The OP can't expect to invest at the beginning of his career in 1929, and take his money out in June 2004-- that would be a working life of 85 years. Rather I am assuming invest in 1929, and retire in 1959.
The point being that whilst stocks have been a winner, one cannot guarantee the kind of returns over the next 30 years that have taken place over the last 30 years.
This is the paradox of stocks and compounding. You compound *down* as well as up. You have more money, but a bear market therefore hits you harder. The advocates of stock investing always assume positive returns-- a good assumption, but not a certain one.

Without checking, my memory of the market fall from September 1929 to 1935.

I though the Dow peaked in 1966, and did not again return to the over 1000 level until 1979. At which point inflation would have reduced your returns by a further 40% or so (might be more).
I don't have the data to hand to check that.
Perhaps you're thinking of

See above. Except on the third point, we weren't really talking on the same basis.

Add pictures here
<% if( /^image/.test(type) ){ %>
<% } %>
<%-name%>
Add image file
Upload
snipped-for-privacy@yahoo.com wrote:

Ah, this was not clear (to me) from your post, sorry about that. Nevertheless the return (again from Shiller's data) from Jan. 1929 to Jan. 1959 was still 558%, or 6.5% annualized after inflation - very near the long term market average.

Certainly true.

Sorry about that again. But during this time period, the market (from Shiller's data) gave up only 11% of the gains made in the 25 years preceding Sept. 1929, adjusting for dividends and inflation.

It did peak in 1966, but returned to that peak in 1968, adjusting for dividends.
Have I mentioned how much I love Shiller's data (though the last sentence wasn't from his data...)?
-Will
Add pictures here
<% if( /^image/.test(type) ){ %>
<% } %>
<%-name%>
Add image file
Upload
Will Trice wrote:

Pesky math. Good thing I'm not a structural engineer or something. This should be a 38% loss, not 11%.
-Will
Add pictures here
<% if( /^image/.test(type) ){ %>
<% } %>
<%-name%>
Add image file
Upload
Will Trice wrote:

OK that is much closer to what I recalled.
The point about compounding holds. *negative* return periods can hurt as much as positive ones help.
The OP was fortunate enough to make early investments, I would guess, in the 1970s. The stock market has never performed as well over a 30 year period as it has since 1979.
However, counting inflation, it had an absolutely torrid time beforehand-- 1968-1979. Something like a 60% drop, I think?
One of the big factors in previous times of stock market return has been the impact of dividends. Accounting for as much as 2/3rds of all stock returns over the 100 year period (about 60% in the US, I believe).
Now, with dividend yields hovering around 2%, it is much less clear that those dividends will be such a big factor in returns going forward.
Add pictures here
<% if( /^image/.test(type) ){ %>
<% } %>
<%-name%>
Add image file
Upload
snipped-for-privacy@yahoo.com wrote:

Sure it has (assuming that I understand your statement above - I don't have a very good track record on that...). Thirty year periods (adjusting for dividends and inflation) beginnning in 1979 and later returned 7% to 8% annually, until you get into the 30 year periods ending after 2001 (where the returns go lower). But 30 year periods ending in 1961 through the early 70's had 8% to 11% annual returns. Periods ending in the mid-50's had 7% to 8% returns. ~7% returns for 30 year periods ending in the late 20's. Periods ending in the early 1900's had 7% to 9% annual returns. Admittedly the 90's bull market had impressive single year gains that we should not expect to be repeated, but we had a nice bear market afterwards and plenty of years of high inflation before to temper the 30-year perspective.

More like 30% (adjusting for dividends).

This may be true over the next 10 years, but if you're looking out 30 years, I think this is a pretty shaky statement. Of course, if you had stated the opposite (i.e. dividends will be a huge factor going forward), that would be equally shaky.
I understand your point that the future may not resemble the past. But 30 year returns have been pretty stable. Using the 90's as an indicator of future stock market investing success would seem to put one on the road to disappointment. But to throw the baby out with the bath water (or the equities out with the bull market), seems a bit too doomsdayish.
-Will
Add pictures here
<% if( /^image/.test(type) ){ %>
<% } %>
<%-name%>
Add image file
Upload
Will Trice wrote:

1. 'the power of compounding' works both ways: if you have negative returns, your portfolio takes the hit. This is the problem with the blithe assertion (made mostly by financial planners seeking to sell me stuff) that all you need to do is sit back and get rich, or that compounding is the solution to all evils.
The good news is that whilst 1929 and 1999 were lousy times to invest, 2007 doesn't look anything so horrific, even if markets might drop 30% tomorrow (assuming a major event like a war with Iran).
2. equity returns tend to be positive over the long haul. In fact, 'excessively' so relative to their risk levels (volatility)-- this is a puzzle in financial market theory and *likely* results from the fact that investors are excessively adverse to capital losses (so they don't hold as much equities as they should).
This may be the source of the stability of 30 year returns.
http://www.arrowstreetcapital.com/pdf/triumph_of_the_optimists.pdf
US - 6.3% real return 1900-2002. If inflation is 2.5% pa going forwards, then this is consistent with a 9% nominal return.
US, Canada, Australia and Denmark never experienced negative 20 year real returns. Of course taxes completely muck up this calculation (tax deferred accounts weren't around for much of this period). And I wonder what the situation was in Denmark during the Nazi Occupation-- is it meaningful to speak of an equity return then?
3. if you start at a lower yield basis, it's hard to catch up. From a 5 or 6% yield (I am not sure what the SP500 yielded in 1976, but I believe it was around that level), you can see that even if the market does well, dividends are going to be a decent slug of your return.
This is much less true from 2%. Even if dividends grow quickly. *unless* somewhere in there we have a stockmarket slump that brings dividends back to their historic level.
I'd have to sit and do the math, but if we assume that dividends rise by 5% pa, over that time, the yield basis of the market only doubles every 14 years, so in that period your dividends have risen by 4 fold, but (assuming 8% pa return) your portfolio has risen by 10 fold.
4. the best predictors I know of returns (long run) for asset classes are:
- real return of equities: inverse of the normalised PE for the stock market. So if the SP500 is on 15 times PE right now, then 6.7% real (big argument what constitutes a 'normal' PE given the market is always either headed into a slump, or coming out of one (by definition)).
- nominal return of bonds: their current yield to maturity (about 4.6% I believe)
- real return bonds: their current real yield (ie TIPS in US)
I think Brenan on the Vanguard website had a piece on this. I am quite comfortable that those are reasonable forecasts for future returns.
Dimson uses slightly lower (see the piece I quoted and his book) at 5% real. He finds a 20% chance of a negative real return on a 20 year holding period, and a 6% chance on a 40 year period.
Add pictures here
<% if( /^image/.test(type) ){ %>
<% } %>
<%-name%>
Add image file
Upload
snipped-for-privacy@yahoo.com wrote:

Well, if the S&P drops by 30% tomorrow, you're almost to the point where it dropped from 1999 - 2003 (dividend adjusted). But I guess your point is that the markets don't look as overvalued as they did in '29 or '99 by certain measures?

As Shiller points out in _Irrational Exuberance_, this is not true. The 20 year period ending in 1921 experienced a negative (barely) overall real return. He points out that after taxes, there are a few more 20 year periods with negative real returns. For what it's worth, Siegel in _Stocks for the Long Run_ looks at the long term stock market results of several countries including Germany during the Nazi era. I don't remember if he looked at Denmark, though. I was surprised to see that both the German and Japanese stock markets recovered nicely after WWII (you could have held all the way through - if you had a long enough horizon), while their bonds went in the crapper (not surprising). This is one of the effects that leads Siegel to claim that stocks are safer than bonds over the long term.

Here you're making the assumption that dividend yield is a necessary part of total return. Some would say that a low dividend yield would necessarily lead to higher capital gains as the total return should be somewhat stable. I won't go that far, but I do note that 30 year real returns, adjusted for dividends, are not correlated to the dividend yield at the beginning of the 30 year period (again using Shiller's data). And while dividend yields are remarkably low right now, dividend growth is also very high (up to 15% in 2004).
-Will
Add pictures here
<% if( /^image/.test(type) ){ %>
<% } %>
<%-name%>
Add image file
Upload
Will Trice wrote:

Yes I should have been clearer. There is nothing like the 'irrational exuberance' out there *although* there are some troubling vulnerabilities in the financial system (specifically the complexity of the interrelationships between the banking system, hedge funds, LBO loans, collateralised debt and credit default swaps) and perhaps a sense of complacency (extremely low volatility).
(other areas of risk would be commodity prices and real estate prices).
Commodities we know what is happening. Historically, you could make money in commodities from the backwardation (the futures price is normally lower than the spot price by more than the interest cost over the time period), so by holding a basket of commodity futures, you make steady money on the 'roll'. Steady money, and uncorrelated with stock markets.
Unfortunately, enough studies have shown this, so that big money from institutional investors has been shifted into commodities (and a lot of speculative money). At which point, commodities are now in contango (futures price higher than spot price) and the 'roll' is a money loser.

I guess Dimson and Shiller are using different indices. Without doing a bit of digging I am not sure why. Dimson does state he is using data that is about 0.5% pa lower in returns than the usual (which makes the disagreement even more surprising-- one would expect Dimson's data to be more pessimistic).
For what it's worth, Siegel in

I guess the question of confiscation comes to the fore. Certainly if you were Jewish, you weren't around to get your stock back (the source of the Swiss lawsuits now). But I'm not sure if you were the average German mutual fund holder (assuming they had such things) you had your property returned to you. Certainly not in East Germany.
The real killer is hyperinflation. Your holdings can be reduced to worthless. Equities *should* be proof against this (providing you don't sell them to eat) but then of course there are the recurrent governance problems from emerging markets. Most notably Russia (the managers simply steal the assets of the company) but also China (your partner is a government which does what it wants).
This

The argument there is that for tax reasons, companies now buy back shares (which used to be almost illegal in the UK, and still is I believe in some countries) rather than pay dividends directly. It's not a bad argument, although I have seen studies that show that far more companies announce buybacks than actually execute them-- it often has more to do with dilution due to executive share options than with company performance.
Most analysts seem to adjust the market yield for buybacks by about 0.5%. ie an SP500 yielding 2.0% would be 2.5% like-for-like.
I won't go that far, but I do note that 30 year real

I was simply noting Dimson's research (elsewhere) that over half the return from holding stocks in the long run is the dividend. Now this has all sorts of issues: 1. tax would have therefore killed your returns for much of the century (taxation on dividends was as high as 90% in some times in UK history) 2. there's no way that can be true in the future, starting at a yield of 2% *unless* as you point out, you get extraordinarily high dividend growth going forward.
Interesting point about yield and returns.
And while dividend yields are remarkably low right now, dividend

Good point.
Add pictures here
<% if( /^image/.test(type) ){ %>
<% } %>
<%-name%>
Add image file
Upload
Will Trice wrote:

Thanks for your data corrections. I am surprised at a couple, will have to add the book to my reference list.
Particularly surprised about the 1929-1935 data. My own memory was that if you invested in 1929, it was in the 1950s before you recovered your position.
Add pictures here
<% if( /^image/.test(type) ){ %>
<% } %>
<%-name%>
Add image file
Upload
snipped-for-privacy@yahoo.com wrote:

Well, you're right, if you ignore dividends and inflation (in other words, you're looking just at an index without dividend adjustment). But this was a very low inflation period overall (with a long period of deflation) and, as you pointed out in another post, the return from dividends was high.
-Will
Add pictures here
<% if( /^image/.test(type) ){ %>
<% } %>
<%-name%>
Add image file
Upload

BeanSmart.com is a site by and for consumers of financial services and advice. We are not affiliated with any of the banks, financial services or software manufacturers discussed here. All logos and trade names are the property of their respective owners.

Tax and financial advice you come across on this site is freely given by your peers and professionals on their own time and out of the kindness of their hearts. We can guarantee neither accuracy of such advice nor its applicability for your situation. Simply put, you are fully responsible for the results of using information from this site in real life situations.