Slow and Steady Wins the Race
This famous investor showed that slow and steady really does win. It
is with heavy hearts that we report the recent passing of our mentor,
Charles Allmon, age 94. We are grateful for his long, full and abundant
life, his endless enthusiasm, keen mind and tutelage.
[via Hendershot Investments]
Sunday, February 21, 2016
Wednesday, February 17, 2016
All there is to investing
True geniuses tend to make things simpler, not more confusing. Buffett is no exception.
Buffett simplifies investing down to the following:
“All there is to investing is picking good stocks at good times and staying with them as long as they remain good companies.”
That doesn’t sound overly complicated – because it isn’t. Click here to see 17 of Warren Buffett’s best quotes analyzed.
Buffett says there are 3 things that make a successful investment:
1. Good stocks (strong competitive advantage)
2. Good times (low prices)
3. Stay with them as long as they remain good investments (let them compound your wealth)
You don’t have to be a genius to follow this plan…
Buffett simplifies investing down to the following:
“All there is to investing is picking good stocks at good times and staying with them as long as they remain good companies.”
That doesn’t sound overly complicated – because it isn’t. Click here to see 17 of Warren Buffett’s best quotes analyzed.
Buffett says there are 3 things that make a successful investment:
1. Good stocks (strong competitive advantage)
2. Good times (low prices)
3. Stay with them as long as they remain good investments (let them compound your wealth)
You don’t have to be a genius to follow this plan…
Monday, February 15, 2016
predicting long-term returns
There has been some interesting growth in the research out there of
what really predicts long-term returns. And as you know,
ironically--notwithstanding all the headlines about it -- it turns out
that things like GDP growth in the last quarter has almost no actual
predictive value for markets over any useful time period. Certainly, in
the aggregate over a multidecade time period, how much the economy
growth matters, but it has nothing in the way of actual predictive
value.
Valuation is kind of an interesting one, though. What we're finding more and more from valuation is that it's actually still not very good at telling you what's going to happen with the markets in the next six or 12 months and where they are going in the near term. But it's perhaps better than we give it credit for in how much it actually predicts long-term market returns. I suppose in some way the recent research on this really just goes back to Benjamin Graham almost a hundred years ago, who noted that, in the short term, markets act like a voting machine; in the long term, they act like a weighing machine. In the long term, valuation eventually comes to bear and either lifts up returns if things are cheap or drags down returns when they are more expensive.
Benz: So, when you look at various time periods over which valuation tends to be most or least predictive, you said in the short term it's not so predictive, while over longer time periods it is. But very long time periods, again, maybe not so effective.
Kitces: It starts to break down. So, we've looked at lots of different valuation measures of this question of what works. Ironically, some of the ones that are most popular that we talk about most often really don't work very well. Things like forward-looking P/E ratios tend to be very poor at predicting market returns over really much of any time horizon because, unfortunately, we just tend not to get forward earnings correct. Particularly in market returns, we usually don't see the recession coming until it's too late, and then we tend to overestimate the declines and underestimate the turns when they come. So, we find that forward P/E ratios don't work very well. Things like earnings over the past year are a little bit too short term.
The measures we find that work the best are those like the Shiller P/E ratio. It's often called cyclically adjusted P/E ratios, or CAPE, where we actually take 10 years' worth of trailing earnings, adjust them for inflation, and average them out over that whole time period. So, we get something that's kind of smoothed out for all the volatile market cycles, and that turns out to actually have some very powerful predictability of future market returns; but as you said, it's only over longer time periods.
When you look over a time horizon like a year, it turns out that Shiller CAPE is only slightly more predictive than monkeys throwing darts at stocks. It's almost random. It's ever so slightly better, but it's almost random. As the time horizon stretches out, though, it becomes much, much better, and there is actually an incredibly high correlation between Shiller market valuation and returns over the next eight years or so. It's actually quite good, and it explains almost half the variation in eight-year returns. So, it doesn't necessarily tell you how you're going to get there over eight years--it just says that from high valuation points, the market returns tend to be worse over eight years and then from low valuation points, they tend to be better.
Then, when we stretch the time period out even further, it actually starts to break down again. So, we've seen a lot of people say things like, "I'm just going to drag all my retirement spending way down because it looks like the 30-year return on the market has to be bad if valuations are so high." But we actually find that the predictability of valuation for 30-year returns is hardly any better than it is for one-year returns. So, one year is too short--markets happen because they are a voting machine; 30 years is actually too long because whole economies can restructure themselves over 30 years. We really find it's that eight to 15-year time period where it's really powerful, which matters a lot for, say, retirees thinking about sequence-of-return risk and accumulators who might be in their 40s or 50s and could be 10 or 15 years away from retirement and are trying to figure out whether the market is likely to cooperate with their portfolio growth and getting them to the finish line. But you have to be careful not to either focus too short or too long.
Valuation is kind of an interesting one, though. What we're finding more and more from valuation is that it's actually still not very good at telling you what's going to happen with the markets in the next six or 12 months and where they are going in the near term. But it's perhaps better than we give it credit for in how much it actually predicts long-term market returns. I suppose in some way the recent research on this really just goes back to Benjamin Graham almost a hundred years ago, who noted that, in the short term, markets act like a voting machine; in the long term, they act like a weighing machine. In the long term, valuation eventually comes to bear and either lifts up returns if things are cheap or drags down returns when they are more expensive.
Benz: So, when you look at various time periods over which valuation tends to be most or least predictive, you said in the short term it's not so predictive, while over longer time periods it is. But very long time periods, again, maybe not so effective.
Kitces: It starts to break down. So, we've looked at lots of different valuation measures of this question of what works. Ironically, some of the ones that are most popular that we talk about most often really don't work very well. Things like forward-looking P/E ratios tend to be very poor at predicting market returns over really much of any time horizon because, unfortunately, we just tend not to get forward earnings correct. Particularly in market returns, we usually don't see the recession coming until it's too late, and then we tend to overestimate the declines and underestimate the turns when they come. So, we find that forward P/E ratios don't work very well. Things like earnings over the past year are a little bit too short term.
The measures we find that work the best are those like the Shiller P/E ratio. It's often called cyclically adjusted P/E ratios, or CAPE, where we actually take 10 years' worth of trailing earnings, adjust them for inflation, and average them out over that whole time period. So, we get something that's kind of smoothed out for all the volatile market cycles, and that turns out to actually have some very powerful predictability of future market returns; but as you said, it's only over longer time periods.
When you look over a time horizon like a year, it turns out that Shiller CAPE is only slightly more predictive than monkeys throwing darts at stocks. It's almost random. It's ever so slightly better, but it's almost random. As the time horizon stretches out, though, it becomes much, much better, and there is actually an incredibly high correlation between Shiller market valuation and returns over the next eight years or so. It's actually quite good, and it explains almost half the variation in eight-year returns. So, it doesn't necessarily tell you how you're going to get there over eight years--it just says that from high valuation points, the market returns tend to be worse over eight years and then from low valuation points, they tend to be better.
Then, when we stretch the time period out even further, it actually starts to break down again. So, we've seen a lot of people say things like, "I'm just going to drag all my retirement spending way down because it looks like the 30-year return on the market has to be bad if valuations are so high." But we actually find that the predictability of valuation for 30-year returns is hardly any better than it is for one-year returns. So, one year is too short--markets happen because they are a voting machine; 30 years is actually too long because whole economies can restructure themselves over 30 years. We really find it's that eight to 15-year time period where it's really powerful, which matters a lot for, say, retirees thinking about sequence-of-return risk and accumulators who might be in their 40s or 50s and could be 10 or 15 years away from retirement and are trying to figure out whether the market is likely to cooperate with their portfolio growth and getting them to the finish line. But you have to be careful not to either focus too short or too long.
Thursday, February 11, 2016
CMH
In a 2003 contribution to CFA Magazine, [1] Vanguard founder
and former CEO Jack Bogle introduced the cost matters hypothesis, or
CMH. Bogle presented his theory as a substitute for the efficient-market
hypothesis, or EMH, as a means of framing the task facing investors
aspiring to beat the market:
We don't need the EMH to explain the dire odds that investors face in their quest to beat the stock market. We need only the CMH. Whether markets are efficient or inefficient, investors as a group must fall short of the market return by the amount of the costs they incur.
This same harsh math was elegantly laid out by William Sharpe in his seminal 1991 piece "The Arithmetic of Active Management" [2]:
If 'active' and 'passive' management styles are defined in sensible ways, it must be the case that
> before costs, the return on the average actively managed dollar will equal the return on the average passively managed dollar;
> after costs, the return on the average actively managed dollar will be less than the return on the average passively managed dollar.
These assertions will hold for any time period. Moreover, they depend only on the laws of addition, subtraction, multiplication and division. Nothing else is required.
We don't need the EMH to explain the dire odds that investors face in their quest to beat the stock market. We need only the CMH. Whether markets are efficient or inefficient, investors as a group must fall short of the market return by the amount of the costs they incur.
This same harsh math was elegantly laid out by William Sharpe in his seminal 1991 piece "The Arithmetic of Active Management" [2]:
If 'active' and 'passive' management styles are defined in sensible ways, it must be the case that
> before costs, the return on the average actively managed dollar will equal the return on the average passively managed dollar;
> after costs, the return on the average actively managed dollar will be less than the return on the average passively managed dollar.
These assertions will hold for any time period. Moreover, they depend only on the laws of addition, subtraction, multiplication and division. Nothing else is required.
Monday, February 08, 2016
the pivotal age for retirees
Why 70 Is the Pivotal Age for Retirement Planning
For retirees, everything changes when they must begin tapping their tax-deferred retirement accounts, says retirement expert Ed Slott.
Christine Benz: Hi, I'm Christine Benz for Morningstar.com. The first baby boomer turned 70 in early 2016. Joining me to discuss why age 70 is such a pivotal age for retirement planning is retirement expert Ed Slott.
Ed, thank you so much for being here.
Ed Slott: Great to be back here live in Chicago.
Benz: It's great to have you here in the studio. Let's talk about age 70. A lot of people focus on age 65. That's maybe the year when they plan to retire, but a lot of important financial-planning considerations hinge around age 70. Let's talk about what changes for retirees at that age.
Slott: Well, everything changes because of the tax code. As most people know, that's the change part where you move away from accumulating money. Remember, you spend 30, 40, or 50 years working, saving, and investing in an IRA or a 401(k), and the money in these tax-deferred accounts hasn't been taxed yet. But it can't sit there forever. So, the government, years ago, decided, "Let's make it age 70 1/2" for some crazy reason--and nobody knows why. That's the date when they finally tell people, "We're sick and tired of waiting for you to drop dead--we want our money back."
Now, you have to go in a different direction. Instead of saving and saving and saving, now they want you to start taking this money out--whether you need it or not. The government is going to force you to take that money out, pay tax on it, increase your tax rate, increase your liability--even if you don't need the money. And you have to do this for the rest of your life or until your IRA or 401(k) runs out. They're called required minimum distributions.
For retirees, everything changes when they must begin tapping their tax-deferred retirement accounts, says retirement expert Ed Slott.
Christine Benz: Hi, I'm Christine Benz for Morningstar.com. The first baby boomer turned 70 in early 2016. Joining me to discuss why age 70 is such a pivotal age for retirement planning is retirement expert Ed Slott.
Ed, thank you so much for being here.
Ed Slott: Great to be back here live in Chicago.
Benz: It's great to have you here in the studio. Let's talk about age 70. A lot of people focus on age 65. That's maybe the year when they plan to retire, but a lot of important financial-planning considerations hinge around age 70. Let's talk about what changes for retirees at that age.
Slott: Well, everything changes because of the tax code. As most people know, that's the change part where you move away from accumulating money. Remember, you spend 30, 40, or 50 years working, saving, and investing in an IRA or a 401(k), and the money in these tax-deferred accounts hasn't been taxed yet. But it can't sit there forever. So, the government, years ago, decided, "Let's make it age 70 1/2" for some crazy reason--and nobody knows why. That's the date when they finally tell people, "We're sick and tired of waiting for you to drop dead--we want our money back."
Now, you have to go in a different direction. Instead of saving and saving and saving, now they want you to start taking this money out--whether you need it or not. The government is going to force you to take that money out, pay tax on it, increase your tax rate, increase your liability--even if you don't need the money. And you have to do this for the rest of your life or until your IRA or 401(k) runs out. They're called required minimum distributions.