It should occur to the investor that the traditional investments are self-serving to the Silo from which it comes, all too often. Perhaps the way to explore the motivation, and the opportunity, should start with some basics on the investment community.
Investment firms have historically made a substantial portion of their profits from the issuance and distribution of new securities. (Let’s ignore the derivatives boom, and proprietary trading for now). The evolution of the industry over the last 100+ years has certainly been centered on catering to corporations such as Ford, General Motors, et.al. The subsequent distribution of stocks and bonds to retail investors, while important, changed a bit (from an investor’s viewpoint) over the last 30-40 years.
If you review the return on investment (ROI) prior to 1980, it may surprise the investor that the stock markets’ cumulative rate of return from, say, 1929 to 1980 is less than 4%. Unfortunately, or fortunately, we are predominantly an optimistic people. We tend to remember the good, and expect more of it. The investment/economic/growth statistics reflecting 1980 – 2000 show a cumulative rate of return of over 13%. What we tend to believe is that it was always so. We grew up in that environment; if we lived and worked during that period, it was real. If we lean on someone that did so, we tend to absorb it like it was our own experience. The common belief that “the market always goes up ~10% per year comes from that era. Isn’t it funny that we tend to believe it’s also true for the years 2000 – 2011? Reality for the stock market results for that period is closer to no return over all. Yes, there are some good results but, over all, lackluster at best over a long period.
The investment industry allows for some questionable practices. First, the use of “arithmetic average” when expressing investment results is huge. Example:
I have $1, which I invest for a year, and in that year, I get a 100% return. What do I have? $2. Second year, I suffer a 50% loss; my holding? $1 again, correct? Average return? Up 100%, then down 50% (100-50=50) over two years = 25% (50% change/2 yrs = 25%).
Where is my 25% gain if I have the same $1 I started with? Now throw in the fees, taxes, “lost opportunity cost”, and you get a sense of horror.
Point is that the easiest way to express ups and downs might be that percentage/average thing, and there’s what so frequently happens.
The remedy is to actually get away from arithmetic averages, to calculate real returns and to invest according to a sense of reality. Easy, right? Not really.
Here’s a take on the real problem: Volatility with a capital V.
Pre-1980, with that <4% cumulative rate over many years, volatility certainly existed but the landscape was different for the public. We had some expectations of being required to finance our own retirement, but we had some possibility of working for a company with retirement benefits, and we had a shorter life expectancy. The stock exchanges (there were fewer than today) had lower volumes and smaller price moves than we’ve grown accustomed to today. The fixed income market (bonds) pre-1978 was more staid and conservative; there was the “Yield Book”, a handbook that was used to determine yields for investors at any given maturity vs. price. Calculators/computers were later brought into the markets and with that, more volatility (a discussion point for another day). Imagine a bond market where daily price changes were so lacking in volatility that you could occasionally just open a manual and quote a price, and that price was solid for some time!
It was a series of factors that created the 1980 – 2000 growth spurt that gave us some of what we have today.
Next topic, factors of 1980 – 2000.