Estimating Future Returns of the S&P 500

A few months ago, we posted a chart from Goldman Sachs that emphasized how remote the possibility of a 10% annual return for the next 10 years in the S&P 500 would be.

Recently, we found this chart from David Merkel at The Aleph Blog that forecasts future returns using a methodology of his own. Its average forecast is a 4-5% annual return for the next ten years.

4-5% annual return for S&P 500 is most likely result for next 10 years

Forecasts like these are not meant to predict exactly what the stock market will do in the years to come. Instead, they can act as a reality check for investors whose expectations for future capital gains may be too optimistic.

Source: David Merkel at The Aleph Blog

A Constraint You Can Use to Improve Your Investment Decisions

Investing one’s savings is about keeping your decisions consistent and not letting your emotions stray you off course. I read good comments by two bright individuals on this subject last week.

After the financial crisis in 2008-09, investor Joel Greenblatt made the point that the error many people made was owning too much stock so that when the value of their holdings declined 50%, the shock to them emotionally led to a panic decision to sell at the wrong time.

A simple test: the amount of stocks you own should be an amount that if it declined 50% in value in the interim, you would not be too upset.

Professional gambler and investor Haralabos Voulgaris had similar advice for a person asking how to approach investing in Bitcoin: “Don’t buy more than you can afford to lose, set it aside, don’t sweat the day to day nonsense and hold.” The same advice can be used for stocks.

Sources: The Brooklyn InvestorHaralabos Voulgaris

Timing The Market Doesn’t Add As Much As You Think

Some of the best investors of recent decades (Warren Buffett, Seth Klarman, Howard Marks, etc.) are holding greater amounts of cash in their portfolios today than they typically do.

It is an easy observation to say there are fewer investment bargains available in the marketplace than one historically would find. The question is how much does “timing the market” (holding more or less cash in your portfolio depending on the market environment) add to your total returns in the long run?

Nir Kaissar attempted to answer the question and his findings show it’s not much, even if you are good at timing (which most investors aren’t).

With the benefit of hindsight, Kaissar created a market timing strategy that would invest in either stocks or Treasury bonds depending on how high stock valuations were. The value added was just 0.3% per year.

Another case study was looking at the cash Warren Buffett kept on the balance sheet of Berkshire Hathaway over the last thirty years. On average, 9% of Berkshire’s assets were cash since 1987, but this fluctuated from as low as 1% to as high as 23%. Buffett’s discretionary cash positioning was better than keeping cash at the average 9% of assets for the full thirty years, but it only added 0.1% to the firm’s total returns.

The simple conclusion Kaissar comes to is that for the legendary investors, it’s not the market timing that makes them legends but the outsized returns of the companies they do choose to invest in.

Source: Nir Kaissar at Bloomberg

PS – Buffett touched on this subject himself in his 1994 annual letter to shareholders. He recognizes their best purchases historically come when macro event worries are at a peak but does not pay explicit attention to them.

We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen. Thirty years ago, no one could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points, or treasury bill yields fluctuating between 2.8% and 17.4%.