82 Years Is Not Enough

Rick,

People have been investing in the stock market for the last 10 years and have not received any risk premium. But the POTENTIAL is there and that's what investors have been looking for. We enjoy being sold the potential in the market, even if it never arrives. And Wall Street is more than happy to oblige us...

The stock market will remain as long as gambling remains. And that will be a long time...

Investing in the stock market is a gamble, but then again, so is entrusting your future entirely on an employer. Although I don't recommend a person squandering their life savings in stock, I do recommend they invest a reasonable percentage in some type of investment. I dabble in business, real estate, and yes stocks are something I am looking at now. In fact, I am seriously looking at stock in Mentor Capital (MNTR), because of their 20% interest in a biotech company working on FDA clinical trials for a breast cancer treatment that exposes cancer cells enabling the immune system to fight the disease more effectively. I believe the stock value will go up if this treatment makes it to the market. Financial statements made on www.BreastCancerInvesting.com make this investment very appealing.

All gambling is based in denial. What makes it enticing is that the negative expected return is offset by huge variance, thus even the suckers can win some of the time. The recreational gambler on a weekend in Vegas accepts this as the charge for his entertainment. The degenerate gambler has a pathological need for the action.

Wall Street is equipped to accommodate them both, but unlike Vegas offers an alternative course for those who are patient and disciplined enough to accept market returns over any given period of time. As is discussed quite well here, there is no guarantee it is going to work for you, for me, or anyone else. But the potential is real and the chances are favorable because capitalism, for all its problems, really tends to work out over time. Enterprises that create wealth through the provision of valuable goods and services offer a positive expected return on their capital.

Just as the last decade of zero risk premium should not convince anyone that equities are a sure thing over long periods, it also does not convince me that the premium is gone forever (now that's a LONG time!).

Cheers, Paul Meloan

I disagre that we only have 82 years worth of data - yes if we are only considering established stock markets and exchanges - however date can be traced back over centuries in terms of merchantsinvesting in a project (business) and thereby takin risk in anticipation od a share of the proceeds - eg merchant ships over the last 5 centuries - or rice farmers in ancient Japan - the same principals of ris/reward apply as the investor had the alternative of keeping his fortune, buying gold, or land but chose to allocate to a business venture in expectaion of a return ahead of 'safer' assets.

All the more reason that we as advisors spend more time thinking about investors instead of investments.

It is beyond dispute that the moment-to-moment movements of investments are unpredictable, sometimes wildly so (think "A Drunken Stagger Down Wall Street" would make a good book title?), but the movements of investors can be frighteningly predictable. A sound plan allows investors the confidence to deal with markets like 2008-09 with resolve instead of panic, and compared to their fellow citizens that is about the best anyone has a right to demand.

For the real investments (versus speculation, versus gambling) the question remains does this investment have a positive real expected return? I think for the major asset classes we have answered "yes" but to a degree of precision that remains troubling. Better get used to it!

The real data problem is not so much that n=82, which is bad enough, but really n=1 for each of us, as we only have one opportunity to live and experience what the world has to offer us.

Hi Paul,

A sound plan allows investors the confidence to deal with markets like 2008-09 with resolve instead of panic, and compared to their fellow citizens that is about the best anyone has a right to demand.

Resolve beats panic by a ton. But, is that the best an investor has the right to demand? A positive expected return is necessary before I invest, but what happens when that expected return fails to materialize. How do investors handle their n=1 retirement years? Poverty is not the answer.

Shouldn't an investor have the right to demand that his/her investments be guaranteed not to decrease in value by more than, say, 10% in any given year? I know that I demand that right. Whether I, or any investor, chooses to exercise that right is a personal decision. Some will take that guarantee, others will forsake it in an attempt to earn larger profits.

What I want to know is: Do you, or other professional advisors offer that guarantee to your clients? Are you aware that such a guarantee exists?

Regards,

>So for us to pretend that the equity premium is the birthright of anyone willing to stay the course for >10, 20, or even 30 years might be something we want to reconsider.

I don't see how the stock market can continue to exist if it isn’t likely to offer some premium over fixed investments over the long run. If stocks chronically underperformed then no one would be willing to take the risk of investing in stocks vs. CDs. I think you are predicting the end of the stock market. How likely do you really think that is? I agree we can't count on a certain % return. If fixed returns remain at 3% stocks could only return 4-5% in the long term, ouch!

For the purpose of planning what else can we do but look at the historical data and deduce a likely (not guaranteed) rate of return, then adjust if reality is different?

-Rick Francis

@Rick: One of the reasons it is called the equity or risk premium is
that there have been, and will continue to be long periods of time
where it does not exist.

Some of these periods are long, like 30 years long. So no I'm not
predicting the end of the stock market. What I am saying is that it is
time we understand that the risk premium is called that because it is
far from certain.

Far from a prediction, this is history.

Hope that helps.

I agree that a greater sense of humility is very much called for.

I think that the problem is that putting our money at risk scares us. So we demand certainty from our money advisors. Because they need to win our confidence to collect fees, they pretend to be able to provide it. The reality is that our knowledge of how stock investing works is primitive.

When we pretend otherwise, we cut off learning experiences. That's the worst thing you can. What we have done in recent decades by buying into all sorts of dogmas as if they were religious truths is to hinder efforts to develop genuine insights that otherwise could help us to quiet our fears over time.

Rob