Deconstructing 11%: The Road to Madness?

[gratefuled]

So it's generally held that 11% is the plug-in rate for long-term nominal equities returns, based on history. Problem is: prove it.

The number I'm most inclined to use in my own modeling is the SSA's estimate that long-term real equities return has been 6.5%. Great, so if I use that I can avoid a CPI deflator in my model (3.41% average since 1914, by the way.) But I don't believe CPI (or PPI) is comprehensive enough, and the maddening thing is that if I inflate the 6.5% return by the 3.41% CPI average, I'm still nowhere 11%.

My conclusion after a few hours of research is that there's much convention and little science in 11%. I've searched this board for a similar thread and I've Googled all of cyberspace, and I haven't found a firm footing for that number. Maybe I'm missing something?

Ed

HI Ed! My view (yep, I always have one ) on the
11% is this. If the 11% was an absolute proven and accepted number, I would still eschew stocks in favor
of predictability of return. My "accumulation" phase
is over. We are just spending what comes in and I need
to know pretty accurately what that is, and I don't have time to wait out a long bear market. Thus, over a
century of data supporting the 11% still wouldn't push me into equities.
That's just me, and I don't recommend this to anyone
else.

JG

[azanon]

The figure i've heard is 10.5%, but again its going to vary depending on what index you're looking at. I believe small caps have produced a number closer to 12%.

Past performance is no guarantee of future results, but what the hell else are you going to go on?

JG, most experts stay stocks are only appropriate for monies not needed for at least 5 years. Of course the money you plan on spending within 5 years shouldnt be in stocks.

[unclemick]

-2% for the next twenty years. That's right -2%.

If you take current div. plus economic growth(inflation baked in) plus P/E and the old no. 2 pencil and a hand held calculator and pencil out some cases based on history you can really swing with the numbers.

Hint - drop the P/E down to 6 or 8 over a period and see what happens.

Heh, heh, heh - but I'm just a cynical old phart - although I did keep DCA investing though the modest flat from 1966 - 1982 (18 yrs).

[azanon]

Quote:

-2% for the next twenty years. That's right -2%.

From what i understand, there has never been a year go by without doomsday forecasters, especially post depression. *

Growth stocks are still at bargain prices if you ask me; relative to what people are willing to bid them up to anyway. *Forget P/E's, lets go more simple. *In the 20th century, the nasdaq exceeded 4000. *Its just over 2000 now. *Simple math that's easy to understand. *If that's too complicated, think of your local grocery store. *Your favorite munchy that used to be 2 dollars is now 1 dollar. *Are you going to say it still costs too much?

The 90s showed how worthless P/E's really are at predicting stock price movement. *P/Es went WAY past the norms, far beyond a point that would have suggested its time to sell. Heck, most of the real money makers had no PE (cause they weren't profitable, ie: dot coms)

[gratefuled]

See what I mean? The road to madness.

I'll phrase the question another way: why 11%?

Has any broad-basket index returned 11% for a period of time similar in scope to the CPI measurement, i.e., since 1913 or thereabouts?

If so, where's the data? Show me hard science.

Thanks...

Ed

[azanon]

Guess i'm not following you Ed. *You just not believe the statistics? * Broadbase indicators of the stock market show about 10.5% return since the turn of the century. *(not sure why you chose 1913). *Have you tried using your search engines?

Here's one site i found with a quick yahoo search: http://www.bigstockplays.com/stock_market_history.htm

[RockMiner]

I agree this debate is a form of madness.

11% or 10.547321% ? You're kidding right?

I reccomend reading "The Coming Generational Storm" (for starters) and then decide if using the past performance of U.S. financial markets as a predictor of the future still makes sense.

I think using any such assumption in personal financial planning is a very risky form of "anchoring".

Things change.

[azanon]

We're not debating 10.5 vs 11 Rock. *He just wants proof that it really returned ~ 11% in the 20th century. *My response is there's proof everywhere you look. *That the market returned 10-12% in the 20th century is common knowledge supported by a wealth of data.

> I'm familiar with the coming generation storm, and there may be some merit to that. *But that's 2009s problem not today. *Today there's money to be made in the market.
> If you ask me, a lot of boomers realize they're behind now on savings, and are probably trying to catch up by investing in stocks. *I predict in the next 5 years or so, the market could be really strong in this final phase for boomers.

[newellcr]

Ed,

Why drive yourself insane? Take control of what you can (investment rate, investment choice, lower cost investments, etc.) and let the market and inflationary pressures do what they will. I think the 6.5% real rate is just fine for planning purposes. These numbers are used for plans, not answers to what day and hour the market will be at a certain point. There is no science to it. Pick a number and use it. Adjust your plan occasionally to deal with the current reality and that's it.

You aren't going to find an answer - just more questions, so my advise is to not worry about it.

Kind Regards,

Chris

[gratefuled]

Azanon, you're exactly right about what I'm looking for.

Not: "What is the number?"
But: "What supports the 11% number (or by extension, numbers in the 11% ballpark?)"

I agree that debating over a half-point on a fifty-year horizon is not terribly productive. That's not really my point...what I'm getting at is that the convention wisdom doesn't seem to be well-supported.

Maybe I'm just not searching correctly. But I've Googled the crap out of this, and this page (referred by azanon) is typical:

http://www.bigstockplays.com/stock_market_history.htm

There are several problems with the information on this page, and all are typical of what I see in the search engines.

1)Sources aren't attributed.
2)The page uses the phrase "the stock markets" when as best as I can tell it's talking about the DJIA.
3)The data is grouped by decade; individual years aren't listed.
4)The page isn't current to 2004.
5)Do these rates include dividend reinvestment?

See what I mean? "Everyone knows" and "there's a wealth of data out there" and such catch-phrases set my contrarian signal klaxon to whooping like nobody's business.

Ed

[azanon]

1)Sources aren't attributed.

Again, the data's going to be there. *If the numbers actually added up to something else besides what you've heard, we'd all know about it. *

2)The page uses the phrase "the stock markets" when as best as I can tell it's talking about the DJIA.

What's wrong with the Dow? *You almost make it sound like you couldnt put together a portfolio that mirrors the dow.

3)The data is grouped by decade; individual years aren't listed.

Who cares about the individual years, unless one's worried about short term volatility? *If short term volatility is a main concern for you, then stocks aren't an appropriate investment choice for you anyway. *

4)The page isn't current to 2004.

So? *The dow dropped a lot from 00-02, and its back to original levels today. * Mathematically, that 0% performance for 4 years might drop that 10.4% to 10.2%, at most. * You can know exactly how much it would drop it by doing the math (10.4 x 100) + (0 x 4) /104.

5)Do these rates include dividend reinvestment?
Yes. *Can you imagine if they didnt It'd be a lot higher real return than 10.4%!

To answer your question with a question, do you have a better alternative for long-term investment? * Sure, i like some other choices as part of a diversified portfolio, but I think any good long-term portfolio is going to include some stock.

[Hyperborea]

I've currently got an excellent source for long term investment data on loan from the local university library called Triumph of the Optimists. *It has market, inflation, bond, bills, and exchange rate information on a decade basis along with some pretty graphs for the US and 15 other countries. *Do realize that the exact numbers will vary somewhat with the start and end years chosen.

For the US from 1900 to 2000
Nominal Return on Equities - 10.1% Geometric and 12.0% Arithmetic
Real Return on Equities - 6.7% Geometric and 8.7% Arithmetic

P.S. The book is very good but it doesn't have the year by year data which I understand is only available at a cost. *This data has value and people are willing to pay money for it so they are not going to give it to us for free.

P.P.S. *You might be interested to know that Australia had better returns.
For Australia from 1900 to 2000
Nominal Return on Equities - 11.9% Geometric and 13.3% Arithmetic
Real Return on Equities - 7.5% Geometric and 9.0% Arithmetic

[laurence]

O.K., so I didn't read "The coming Generational Storm", but a lot of the doomsday talk about the baby boom retirement seems to assume every baby boomer will retire at say, 10:43 am December 14th, 2009. Of the half dozen people nearing or at retirement age around me, one has saved nothing, one has some stock holdings but will be ritiring mostly on SS, paid off house, and company pension, three others just started saving, and one plans on working until he dies. Am I missing something? I'm open to the possibility that I'm just ignorant, but while the number of people participating in the market has shot up to something like 40%, most of them, I believe, have rather insignificant holdings (10k-20k tops). I haven't been convinced that there is a problem....yet.

[azanon]

Quote:

Of the half dozen people nearing or at retirement age around me, one has saved nothing, one has some stock holdings but will be ritiring mostly on SS, paid off house, and company pension, three others just started saving, and one plans on working until he dies.

Aint that the truth. *What's up with people. * Did some inspections recently with a fellow workmate nearing retirement. *He said he plans on retiring the day he's eligible 2 and 1/2 years from now. *

He was asking me how he thought he should allocate his TSP, and i gave him some suggestions then he interjected well i'm not too worried about it cause I dont have that much in there.... just 50K. * *50K!! *OMG, i would lay an egg right there if he were me. * *I have almost 100K in savings and i'm 33 years old, and I worry i'm behind sometimes. *Worse, this guy is in the old CSCR system (or whatever the acronym is);.... the one with no social security.

Anyway... back on topic, looks like hyper's book is supporting the same thing i've read countless times - 10-12% over the past century.

[malakito]

Quote:

1)Sources aren't attributed. 2)The page uses the phrase "the stock markets" when as best as I can tell it's talking about the DJIA. 3)The data is grouped by decade; individual years aren't listed. 4)The page isn't current to 2004. 5)Do these rates include dividend reinvestment? See what I mean? *"Everyone knows" and "there's a wealth of data out there" and such catch-phrases set my contrarian signal klaxon to whooping like nobody's business. Ed

I'd agree with you that whatever number you choose for return on your investments is an important planning assumption. Even the change of 1% here compounded over a long time can significantly affect the data.

I use 10.7%, which is the return of the S&P 500 from 1926-1997(?). I googled on "Ibbotson 10.7" and got the following link:

http://www.masonstreetfunds.com/lear...investing.html

To answer a few of your questions:

1. Ibbotson and Associates out of Chicago is the source for the claim.
2. They're talking about the S&P500.
3. They don't provide the data by decade or year, but the Schiller data which is available online could be used for that if you're so inclined.
4. I believe it includes dividend reinvestment, as noted in the footnote.

The above URL also points out the 12% small-cap number.

malakito.

[gratefuled]

There we go. Thanks, malakito. I think we're getting close to the headwaters. I'll check that out.

Ed

[newellcr]

Ed,

Just curious, what's the benefit if you find all of the info you are looking for? You seem to be working at this pretty hard.

Cheers,

Chris

[gratefuled]

The benefit's an interesting question.

I read Moneyball last weekend. I enjoyed descriptive statistics in college and I started trying to apply some of the book's concepts to my retirement modeling. Just an interesting way to pass a couple of hours with a cup of coffee on a rainy New England morning.

But I was zooming in on the key assumptions, and I found the raw data proving the 11% convention hard to come by. Surprising for such a famous number...was it famous merely for being famous?

I also like Richard Feynman's writing and lectures, and I'm trying to bring better scientific method to things I study.

And the third reason's that I'm plain damned ornery. "Let X equal a favorable assumption, and then proceed to Y as the desired outcome" is a sales pitch I hear way too often.

Yrs...

Ed