Sunday, July 27, 2014

The problem with "average returns"...

I have long disputed the axiom touted by our financial industry that long-haul equity investment would outperform other assets. Like too much advice it was a facile glossing-over of the actual impossibility of mortal individuals to experience long term average gains.

It turns out timing - spelled L-U-C-K - is a big factor as well. Those average returns are not the same for any particular investor lifetime.
One other scenario year is interesting just for the dramatic disconnect it shows. It involves those fortunate enough at the outset to have a pile of cash to invest. The period from 1975 to 2005 was a stunning three decades for the American stock market, returning 13.7 percent per year. A person who socked away $300,000 in the S&P 500 at the start of 1975 and reinvested all dividends walked away with $14.2 million in 2005.But the pattern of returns was distinctly unfavorable for someone who was a slow and steady saver throughout that period. Some of the years of the sharpest gains came early in that window, like the 38 percent return in 1975 and 24 percent in 1976. And then the last few years were weak, encompassing three straight years of sharp declines to start the 2000s.As a result, our person who invested $10,000 each year walked away with $1.59 million come retirement — nothing terrible, certainly; it was almost impossible to hold stocks during that 30 years without making money. But hardly $14 million.A final note. You can’t control any of this. We all happen to be born when we are born, and the future returns of the stock market are unknowable. As an investor, it is generally best to focus on the things you can control, like how much you save and whether you are putting money in investment vehicles with low fees that are tax efficient.But the luck of when you are born may have a bigger impact on how much you have for retirement than you might like. [More]

Again, I agree that average returns are a good source for basing decisions. Expecting average results is not rational, however. 

Now apply this principle to farmland. How do you think the returns on land bought in say, the last 5 years will match up to acres purchased in 2005, for example?


Anonymous said...

If the land is held, say 40 years, it will be a good investment.

Anonymous said...

In portfolio theory, this is known as sequence of returns risk.

If you haven't checked out this blog before, it is a good one to explore this topic further. It will require some digging, but it is well worth it IMO.

Chuck said...

It depends on the asset you're comparing equities to. If you consider bonds and cash, then stocks have out performed them in every 30 year period in recent history:

30 year returns of stocks, bonds, and cash

Farmland is a trickier subject, because as a farmer you are talking about an active and participatory investment that you can bring your expertise to bear on, and trying to compare it to a passive investment.

Unknown said...

John, just wanted to thank you for another great and thought provoking presentation at the SSI Conference. I enjoy hearing you and reading your blog both for the wide ranging info and to have my personal thoughts challenged. Look forward to continued blogging when you find time.