Jul

7

At times like this it pays to remember why to buy a portofolio of stocks for long run is on average excellent idea :

1. Mean Drift of 3-5% p.a. because of mathematical properties of portfolios composed of shares in USD.

2. Mean Drift of 5% p.a. because the system is "self-adjustedly" skewed; politicians, bankers, companies, media & the entire economy benefits when the market is up.

3. Mean Drift of 5% p.a. as entrepreneurs demand and will get it over risk.

4. Mean Drift of 4-6% p.a., statistics by Dimson, Marsh and Staunton over 100 years and different countries.

However, that was the easy part; it is more difficult for one to sit on his hands, and not override what is backtested and what shall work.

Riz Din runs some numbers:

If you invest $5000 each year in the stock market and earn a rate of return of 7%, after thirty years the total investment is worth half a million. Stay invested for a further ten years and it doubles to just over a million. It doubles again to two million after 50 years. To ensure good returns, it makes sense to invest in one's health and increase the probability of having an abnormally long investment horizon. Also, shooting for a long time horizon may give one the ability to see a playful cub where others see a grizzly ravaging the market.

Alex Forshaw objects:

But after approximating a realistic rate of inflation (3-5%), that number becomes much less impressive.

Other amusing implicit assumptions include

1) zero information costs on the part of the retail investor;

2) zero "oops" moments e.g. auction-rate securities portfolios which end up yielding -20 percent because a bank says so;

3) zero capital gains/ income tax;

4) forex fluctuations masking the enormity of market volatility; and

5) zero probability of not-even-very-extreme events, such as having to liquidate a large portion of your holdings immediately because of a family sickness, job change, etc.
 


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  1. Russell Sears on July 10, 2008 2:01 pm

    Riz,
    Run your numbers again.
    5,000 X 1.07^30 = 38,061.30

    ————-

    Ooops! Sorry riz didn’t read “each year”.  So it is the Future Value of an Annuity: 5,000 X [(1.07^30 - 1) / 0.07] = 472,303.90

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