Chart from New York Times article “Low Interest Rates May Stick Around”. Click on image to enlarge.
Golden Rule of Investing #4: Do not count on extraordinary returns. Be realistic.
Realistic thinking is one of the most important assets we can have as investors, yet it is easy to have an unsound mental framework about investments. If we apply short term data to understand long term trends, our conclusions can be unrealistic.
By the way….in some instances, 50 years can be short term.
A New York Times, article “Low Interest Rates May Stick Around” (1) gives a glimpse of the long term US dollar, interest rate history. This review suggests that those who began investing n the 1960s or later, have a distorted base understanding of interest rates. We expect interest rates to be too high. Our thinking might be, “I can’t wait for interest rates to return to normal.” In fact, dollar interest rates may now be closer to the norm than during a 50 year high rate aberration.
Our base understanding of interest rates may be unrealistic.
The Federal Reserve will most likely raise interest rates this week for the first time in nearly a decade. The majority of investors will expect rates to keep on rising. This thinking could be wrong.
My base view of investing is we should expect 7% to 10% annual return in the stock market as a function of global nominal GDP growth and long term earnings growth plus risk premium. We should expect 4% to 5% return on bonds long term and 2% to 3% on short term interest rates.
Normal returns on bonds and short term interest rates may be lower than previously thought. This increases the need to add risk to long term strategies.
There are ways to increase returns with equities by rethinking this basic thought.
There is an upside to rethinking our strategy. We can expect higher equity returns than 7% to 10%.
This chart from Keppler Asset Management shows that by selecting good value large US equities, the long term expected returns can rise from 10% to 11.3% per annum.
Even better, by taking on a greater risk and investing in good value US small stocks, we can expect a long term return as high as 14.2% per annum.
Here are three tips that can help investing in good value shares.
Good Value Tip #1: Invest during periods of low growth. Periods of low growth are followed by periods of high growth and vice versa. The periods of low growth are the best times to accumulate shares.
Good Value Tip #2: Inexpensive equities in quality companies in good value stock markets are generally the better investments. The last ten years have been a period of turmoil. Investors have turned toward what they have known to be safe in the past: US stock market and the US dollar. However, the US stock market and the US dollar are overvalued when compared to other markets. When a market recovers from undervaluation or contracts from overvaluations, the shares in the market, even good value shares, are lifted or fall due to the market’s momentum. Look for good value markets and currencies as well as good value shares.
Good Value Tip #3: Weighted portfolios of good value shares offer the best return for the long term. Stock picking is always difficult because there is always something we do not know. Good value analysis combined with diversification removes emotional errors and evens out the losses and gains that are the fate of every investor.
We gain the best growth and safety of our savings and wealth when avoiding using short term data to understand long term trends. Since we cannot always determine what is short term, sticking to good value tactics helps overcome the fog we face when looking into the future.