Economic question about returns on investments

[Onlooker]

One of the arguments for allowing people to invest their Social Security is the fact that the market has averaged an 8% return per year for many, many years. There's one obvious flaw with the point, and that's inflation. Inflation has ranged from 50% per decade to 100% per decade, which means the 8% is really only 6% or even 4%.

But, I remember reading that during the Bush recession in 2000-2002 period, while most people lost money, billionaires averaged a 2% gain. So, I suspect that the more money you have the better your gain. It would then follow that for most people the market has averaged less than 8% gain per year over the last 30 or so years, and quite possibly for people who have very little they may average far less (especially when you factor in brokerage fees).

Is my reasoning correct? And secondly, is there amy place that actually lists average market gain as a percentage of investments or something similar?

Of course there are other arguments as well as to why Social Security should not become an investment plan, but I'm just focusing on that 8% figure, which I think is a distortion of reality.

[madrchsod]

1. ss is a better investment

i think it has out performed similar long term "safe" investments over ones lifetime. if the government would have set up the ss in the same way the railroad workers retirement fund is there wouldn`t be an issue with retirement savings.

[papau]

3. true - because funding is near pay as you go with gov bond only

allowed investments of small surplus, future population changes, wage changes and tax changes are the controllers and not the return on investments.

The current tax paid in is more or less paid out immediately as a benefit check to someone.

Bush funds putting real money into real accounts by borrowing that money.

You then pay a tax each year to pay the increased interest on the national debt - as Bush allows you ro get whatever return - after fees - is earned on the portion of the borrowed money put in your account (set to be the size of the payroll tax you paid).

There is no gain to anyone via the account plan - it just destroys SS as a social safety net and requires massive borrowing in the process to get that destruction done.

Can we say "stupid"?

:toast:

:-)

[sandnsea]

19. That's in trouble too

Come on, Republicans can't keep their grubby hands off anything.

http://www.findarticles.com/p/articles/mi_m1316/is_n11_v19/ai_6198305

[Coyote_Bandit]

2. Return on investments

is measured relative to overall market performance (and that would be the market that reflects the securities owned). Over the very long term (the beginning of the depression to about 2000 - or about 70 years) US equity return has averaged about 10% per year and inflation has averaged about 3% per year. Many economists have advised that long term US equity returns from this point forward will be closer to the 7% range.

There is no reason why small investors cannot meet or exceed market returns. Unfortunately, however, all too many folks confuse trading with investing. Investing usually focuses on obtaining value stocks and holding them for the long term. Traders buy and sell frequently and incur substantial costs which diminish their returns. Billioinaires hire money managers who have access to lots of market research and who structure portfolios and exercise investment discipline to avoid high trade volumes. The rest of us are stuck using brokers who churn accounts to generate commissions.

[bbinacan]

6. I'm in the business and

I don't churn accounts. The vast majority of my peers don't. Broad statements like this really piss me off. I provide a valuable and needed service. What do you do for a living?:mad:

[Coyote_Bandit]

16. Delete

[Coyote_Bandit]

20. I too am in the business

Investment portfolio manager. I've worked at a large multinational private bank and at a small trust company.

I've had too many little 85 year old ladies that come to me for asset or trust management. And guess what? Somebody just sold them a large annuity that they cannot cash without significant penalty for another five years - and which pays them no current income. Or they are frustrated with their broker who just bought and sold the latest series of high flyers that generated fees but little equity return. Or they are 100% fully exposed in equities when they really would benefit from a few nice boring muni bonds. Probably the worst "strategy" I have ever seen was peddled by some guys who were selling senior citizens "actively managed" securities (translate that as margined mutual funds holding options and derivatives) that were coupled with and "secured" by the sale of an annuity that accepted a third party assignment back only to be further invested into the same house of cards (another variation in lieu of the annuity was to use a REIT that largely financed church construction). In my experience, these are not uncommon occurrences. That said, there are some very good financial planners, brokers and other financial professionals.

Anybody who works on a commission basis selling anything has a direct financial incentive to put their interests above that of their customers. Most people who buy a car - used or otherwise - recognize that. **You** may not churn accounts - but far too many of your peers do. And some of them hand out some very, very bad advice.

Even the best brokers lack the information and tools to offer the same investment services as professional money management firms. The average small investor is at a decided disadvantage. That is simply how the financial services industry works. Small investors simply do not receive the same level of service in the financial services industry as large investors do.

Unless a broker buys his own equity research from an independent or unless he invests a small fortune into a Blomberg terminal and the time to do the primary research then he simply does not have access to the same kinds of information that investment firms do. And, that is to the detriment of his clients. Analysts from different brokerage houses will issue a wide range of opinions and recommendations regarding the same security. Want an example? Look at GM. Presently there are 4 analysts with a strong sell recommendation, 2 analysts with a sell recommendation, 9 analysts with a hold recommendation, 2 analysts with a buy recommendation, and 1 analyst with a strong buy recommendation. The safe bet is not to buy or sell but to hold. But if you want to take a chance at juicing return then by all means buy GM stock. There are, after all, plenty of good excuses if the bet goes bad. Oh, wait. What you really want, Mr. Analyst, is for somebody else to buy the stock because your company already holds too much in inventory? Then by all means put a buy recommendation on that stock. How many folks really know that your brokerage house keeps an inventory of stocks that they might occasionally want to reduce through market sales? How many folks really understand the inherent conflicts of interest between investment bankers and brokerage houses and their analysts?

Brokers usually cannot and do not offer clients portfolio modeling. The multinational private bank where I worked had about 300 investment models at any given time. And they had the technology to instantly identify accounts by multiple characteristics - and to simultaneously trade in all accounts. This means that all the accounts were treated the same and traded in the same. No client was given preference over another. Brokers usually have to get client direction for trades. Who do you, as a broker, call first? Or last?

Brokers who do offer some kind of equity modeling lack the resources to offer continuously updated equity models designed to maximize client objectives - and their clients are neither willing nor able to incur the fees from the frequent incremental trading required to maintain that portfolio. When was the last time you saw any broker trying to get a client to implement a portfolio strategy based on a theoretically optimal mean variance portfolio modified to meet client objectives (e.g., maximize dividends or return or minimize risk or variance)? It is just not practical except on a large scale.

Small investors face other problems of scale. If you want to implement a balanced investment objective (roughly 50% equity and 50% bonds) using a diversified equity portfolio of at least 25 stocks then, realistically, you probably need an account in excess of $250,000. If you adopt a more conservative investment objective then you will need an even larger account to buy that equity portfolio. This is where it starts getting costly for the average small scale investor. Why? Because they either have to (1) buy stocks in lots of 100 shares and have a portfolio that is not properly weighted, or (2) buy stocks in odd lots and pay the fees associated with doing so, or (3) choose to buy mutual funds (and the associated services of their professional money managers) and pay the fees associated with doing so. Even sophisticated investors will find it difficult to properly diversify a small equity portfolio without incurring additional costs.

Professional money management is cost prohibitive and many management firms will refuse accounts valued at less than $1 million. The most practical way for small investors to obtain professional money management is to buy mutual funds and pay the fees associated with them. And those fees are higher than what is typically charged by professional money management firms where fees are usually about 1% of the average annual account value with direct trading costs somewhere around 3 cents per share. Professional money management fees go up or down based on investment performance within a particular account. There is a strong incentive to provide good long-term advice and to continuously monitor securities held.

Small investors can do well in the market. Historically, the best performing stocks over the long-term are value stocks. These are the stocks that are priced cheap relative to their long term expected return. The trick is understanding whether or not they are cheap for good or bad reasons. Find one that is unreasonably cheap, buy it and hold on to it for years. Ignore all the market ups and downs - unless something fundamentally and significantly changes the long term expected return. Now go replicate that 25 times across market and industry sectors to diversify your market exposure and reduce your risk.

As in everything else, let the buyer beware.

[bbinacan]

21. Wow, quite a dissertation.

I use asset allocation modeling and Modern Portfolio Theory in constructing portfolios. When I can, and it's in the best interest of the client, I recommend seperately managed accounts run by a money manager. Depending on the brokerage firm, investors can get a money manager for as little as 75k. With the recent introduction of combining growth vs. value and large, small, midcap, international, and fixed income in one account (generic term is multi-disciplined account) more opportunities are coming for smaller investors. Yes, larger accounts pay lower fees because of the economies of scale. BTW, I am now with a very good regional bank. Before that I spent 16 yrs. with wirehouses. The last 9 with one of the best know investment banks in the world.

On a side note, I had a long conversation today with a portfolio manager that works for a firm you should know. They are a value manager and have pretty much quit accepting new money. Are you familiar with the "Consistency Ratio" and the "Q-Sort"? I just got the info today and haven't delved into it yet.

You wrote, "Probably the worst "strategy" I have ever seen was peddled by some guys who were selling senior citizens "actively managed" securities (translate that as margined mutual funds holding options and derivatives) that were coupled with and "secured" by the sale of an annuity that accepted a third party assignment back only to be further invested into the same house of cards (another variation in lieu of the annuity was to use a REIT that largely financed church construction). In my experience, these are not uncommon occurrences."

I've never even heard of this. In my experience, this is the exception and not the rule. You must be in Florida or on the west coast.

I hope, in the not too distant future, to go to Wharton for my CIMA.

[bbinacan]

4. Most investors don't enjoy

the gains of the longer term market averages because they are too impatient and sell at the wrong time. I saw a study recently that showed what the average mutual fund return was vs. what the average investor made. I don't remember the actual numbers but the gist was that over a given time frame the avg. fund did 16% per annum while the avg. person made 3 or 4% because they didn't stay in the market. Old expression, It's not timing the market, but time IN the market.

[Common Sense Party]

18. DALBAR had a study, and Davis Investments has a piece

on that. I use this in seminars all the time:

During the 17-year bull market, 1982-2000 (1st Quarter of 2000), the average growth stock mutual fund had an average annual return of 14%.

During the same time, the average growth stock mutual fund INVESTOR only realized a 5.3% return.

Why?

When did the average investor get into the mutual fund? When it was already very high--AFTER it had already seen tremendous returns. When did he get out of the fund? When it went down in value.

The average investor bought high (greed outweighed common sense) and sold low (fear outweighed common sense).

Who got the 14% return? The investor who got in in 1982 and stayed in the whole time, through good times and bad.

A good advisor will encourage his/her clients to invest rationally, not emotionally.

[bbinacan]

22. I know my income

took a big hit after 2000 because I encouraged people to stay the course. They've recovered nicely and are happy they listened to me. Case in point, I opened an account in 1993 and told the client that 8-10%, over time, was a reasonable expectation (it was qualified money). Well of course his account did very well in the late 90s and when it took a 150k hit he complained. I reminded him of our conversation when he opened the account. I calculated his return from 1993 to the lower point of the bear market and he had averaged 9.5% per annum. Sometimes I think the biggest part of our job is managing client expectations.

In 1999, I had a client(inherited)that was averaging close to 30%/yr. He thought he should be getting 50%/yr. I fired him because of the additional risk he would have to take and that risk fell on deaf ears. Thank God I did. I bet his new advisor had hell to pay when the 90s bubble burst.

[cally]

5. I'd be interested in seeing rate of return by amount invested over

the past 30 years. I would expect that the ability of wealthy investors to get better rates than the small time investor has increased in the past 10 years. Regulation of the markets has deteriated. I'm not sure if you would get the same rate differential over time or whether it is a recent trend.

I remember some great threads discussing the 8 percent figure on DU and on Josh Marshall's site. I don't remember the specifics but there are many problems comparing these two figures. I don't remember the specifics though.

[bbinacan]

8. I'll have the answer

for your 30 year question shortly. I need to disconnect from my desktop an reconnect with my laptop, since it has the connections I need. Be right back.

[cally]

11. Thanks

I've seen some great research on rates of return. My info is at work so I can't look it up now.

[bbinacan]

13. Here you go

In the last 30 years,

DOW=8.37%
S&P 500=12.38% and a run of the mill fund used by us evil brokers
Aim Weingarten=13.75%

BTW, SS earns 0 return because it is part of the general fund.:banghead:

[Common Sense Party]

17. Fellow evil broker here.

Just churning and dispensing faulty advice in order to enrich myself--because that's a good, long-term business plan.:sarcasm:

[bbinacan]

23. From one evil broker to

another. Welcome to the Dark Side.:smoke:

[Telly Savalas]

7. A general rule of thumb in finance...

is that the higher the risk, the higher the rate of return and vice versa. The NYSE experiences better returns on average than SS because there's a much higher possibility of losing one's shirt. (Which, y'know, kind of defeats the purpose of a safety net for retirement.)

[scruffy]

9. Over the last 70 years or so

the market has averaged about 10-11% and inflation has been relatively low - around 3% or so.

Having managed investments for clients for many years, I can say from experience that it IS possible for investors to get those kinds of returns - even if they aren't billionaires. The key is to have a diversified portfolio - including assets in areas that go in opposite directions of the overall stock market - and then to leave it alone.

[many a good man]

10. SS: no risk, 3% return; Mkt: hi risk, 7%

As they say in the market, "past performance does not guarantee future returns." The next 60 years will likely be much different than the past 60 years. We face enormous challenges in the near term and we have to do so without a strong manufacturing base, without cheap energy, and facing tough global competition.

The stock market has gone through several periods where it has taken more than 5-10 years make up its losses. For example, adjusted for inflation, the Dow Jones average right now is below its level of five years ago.

The main objective of a social insurance program is to collectivize risk so that all can be afforded a minimal standard of living. Bad luck in the market will lead some to fall below even this minimal level of existence.

[KoKo]

12. Well said. And most investors use their 401-K's and not a money

manger who can give them advice. But, it takes some sophistication to find a money manager that one trusts and for young folks starting out that would be a challenge. Many folks are forced into whatever investments their companies decide should be in their 401-K's and that also can have problems depending on the Manager of the company where one works.

Social Security has been "guaranteed." The stock market can't guarentee.

[bbinacan]

14. Are you implying that

SS gets a 3% return? How do you figure that? It's part of the general fund. There is NO SS trust fund.

[many a good man]

15. Surplus goes into special type of T bonds

Congress gets to spend the cash and the T bond goes into a filing cabinet in West Virginia. When SSA wants to cash that bond the govt will have to find the money somewhere, which will hard to do because we have so much debt. But don't worry, its backed by the "full faith and credit of the United States government." If that goes, we'll have even worse problems to worry about.