Hello All,

I am a young Ag graduating in December, have a job lined up, getting married and will soon be investing. I have looked into all forms of investment and I am a believer in a long term strategy, and no get rich quick schemes. Through what I have looked at, it seems that at face value, S&P Index Funds seem to make the most sense, low costs, follows the market, and returns an average of 7-11% returns over any given set period. The problem I have with this is that average returns and actual returns are VERY different. For example:
I have $1,000... and say year 1 it gets 100% return. Value= $2000...Year 2 it gets -50% return...back to $1000...Year 3 100% gain....back to $2000...and Year 4 goes back to -50% so I have a final value of %1000 EVEN THOUGH my yearly average was a positive 25% return on my money, yet I've gained nothing. The negative impacts of compounding are not displayed through most prospectuses and portfolio performances... Now with that I have considered Real Estate, rental properties and that investment vehicle. I understand the work that surrounds that world and the difficulties that come with it. Beyond that, it seems that a 7 % return not counting appreciation and including expenses seems rather reasonable, and this is an actual return, versus the actual returns of the stock market being closer to 3-4% after inflation...

I mean this post to have others consider this, but also asking advice from more experienced Ags about if I'm coming at this from the right angle, if this makes sense, and if I'm right/wrong... Would love thoughts/ideas/opinions and feedback.

Geometric vs arithmetic means....

The annualized ROI (CAGR) of the example provided is 0%.

The CAGR of the market from 1/1/1929 to 12/31/2016 adjusted for inflation and dividends was 6.16%. That's an arithmetic annual rate of 8%.

Projected returns on rentals can be pretty hard to put an exact number on it. BUT, every time I've calculated backward looking real return on investment on my rental homes I get somewhere between 20-25% annually. This is a 20% down payment with return being comprised of monthly cash flow, appreciation, and principle pay down all combined. That doesn't count any rental tax losses you might be able to count against your W2 income.

With that said, I got most of my homes when you could still find plenty of deals where rent was running 1.2-1.5% of purchase price. Now days, finding 1% is tough.

I appreciate the response. Would you mind defining Geometric vs Arithmetic returns, how you calculate them, and what that means? Thank you.

This is what I have found as well. For the time in which I'll be accumulating a down payment, I forsee a coming Market Correction which will hopefully create some deals, but so far this seems to be the more advantageous strategy for those willing to put in the work.

TheAggieInventor said:

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I appreciate the response. Would you mind defining Geometric vs Arithmetic returns, how you calculate them, and what that means? Thank you.

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Did you take calculus?

Think the change in the area under the curve divided by the time versus the average of the slopes of a few pseudo tangents.

I know this isn't perfect but this is how it clicked with me

TheAggieInventor said:

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This is what I have found as well. For the time in which I'll be accumulating a down payment, I forsee a coming Market Correction which will hopefully create some deals, but so far this seems to be the more advantageous strategy for those willing to put in the work.

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Unless you have some Insider information time in the market always beats timing of the market in the long run

TheAggieInventor said:

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Geometric vs Arithmetic returns

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Compound Annual Growth Rate (CAGR) = (End Value / Start Value) ^ (1/number of years) - 1

In the simple case, all that matters is the change from Start (Buy) to End (Sell). The ratio is percent change. The exponent annualizes the ratio.

Let me simplify it

Year 2000 = $1000
Year 2010 = $2000
100% increase
10 year time frame
10% annual return (100% increase/10 years)

Year 2000 = $1000
Year 2010 = $1000
0% increase
10 years
0% annual return (0%/10 years)

Comprende

gig em 02 said:

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Let me simplify it

Year 2000 = $1000
Year 2010 = $2000
100% increase
10 year time frame
10% annual return (100% increase/10 years)

Comprende

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That doesn't make any sense. Start with 1000, multiply it by 1.1 ten times and tell me what you get.

It ain't $2000.

Your calculation assumes the 10% growth is on the initial investment only, not the compounded gains.

62strat said:

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gig em 02 said:

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Let me simplify it

Year 2000 = $1000
Year 2010 = $2000
100% increase
10 year time frame
10% annual return (100% increase/10 years)

Comprende

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That doesn't make any sense. Start with 1000, multiply it by 1.1 ten times and tell me what you get.

It ain't $2000.

Your calculation assumes the 10% growth is on the initial investment only, not the compounded gains.

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To walk the op from the math in the op to where he needs to go you are going to need smaller steps than jumping straight to calculus. I'm also not going to write a 2,000 word disclaimer just because some people are unable to comprehend the word "simplified"

The simplistic answer to the OPs question is that typical ROI on a rental house (now) after upkeep and hassle will be single digits. You can research that online with a google search.

And the reason why the true ROI, however you calc it on the simplified 4 year stock market example, is actually around 7-11 percent through any 15 year period since early 1900s is because on those down years you continue to buy and ride out the investments with time weighted averages. Over time, through the ups and downs, after compounded growth, you'll have bought in across the range and be much better off than when you started.

As a young gun, start now, and be methodical. You need two market crashes over the next 20 years and you'll be able to retire as soon as you are ready (Provided you spend less than the average fool).

Since 1901, there is no CAGR that's longitudinally above 8%. It doesn't matter what year you use as the base., CAGR regresses to a mean near 6%.

"You need two market crashes over the next 20 years and you'll be able to retire as soon as you are ready"

What? LOL

gig em 02 said:

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62strat said:

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gig em 02 said:

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Let me simplify it

Year 2000 = $1000
Year 2010 = $2000
100% increase
10 year time frame
10% annual return (100% increase/10 years)

Comprende

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That doesn't make any sense. Start with 1000, multiply it by 1.1 ten times and tell me what you get.

It ain't $2000.

Your calculation assumes the 10% growth is on the initial investment only, not the compounded gains.

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To walk the op from the math in the op to where he needs to go you are going to need smaller steps than jumping straight to calculus. I'm also not going to write a 2,000 word disclaimer just because some people are unable to comprehend the word "simplified"

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I'm with 62stat. I found your post was way more confusing than simplifying.

The vast vast majority of people are going to equate "annual return" with Compound Annual Growth Rate (CAGR). In this scenario:

CAGR = (FutureVaue/PresentValue)^(1/N_Periods) - 1 = (2000/1000)^(1/10) - 1 = 7.2%

TriAg2010 said:

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gig em 02 said:

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62strat said:

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gig em 02 said:

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Let me simplify it

Year 2000 = $1000
Year 2010 = $2000
100% increase
10 year time frame
10% annual return (100% increase/10 years)

Comprende

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That doesn't make any sense. Start with 1000, multiply it by 1.1 ten times and tell me what you get.

It ain't $2000.

Your calculation assumes the 10% growth is on the initial investment only, not the compounded gains.

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To walk the op from the math in the op to where he needs to go you are going to need smaller steps than jumping straight to calculus. I'm also not going to write a 2,000 word disclaimer just because some people are unable to comprehend the word "simplified"

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I'm with 62stat. I found your post was way more confusing than simplifying.

The vast vast majority of people are going to equate "annual return" with Compound Annual Growth Rate (CAGR). In this scenario:

CAGR = (FutureVaue/PresentValue)^(1/N_Periods) - 1 = (2000/1000)^(1/10) - 1 = 7.2%

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Let's get one thing straight; while I did take 2 semesters of Engineering Statistics, I am far from claiming I know much about it.

I do however possess and play a guitar of the Fender variety.

CAGR takes the final value and beginning value, and then determines what fixed interest rate would have that outcome given the number of years.

So if your final value is the same as the beginning value, the CAGR = 0. It doesn't matter what path was taken to get to the end, if it doubled tripled halved ten times then went back up. CAGR will give you the equivalent fixed rate return.

Australia_Ag said:

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The simplistic answer to the OPs question is that typical ROI on a rental house (now) after upkeep and hassle will be single digits. You can research that online with a google search.

And the reason why the true ROI, however you calc it on the simplified 4 year stock market example, is actually around 7-11 percent through any 15 year period since early 1900s is because on those down years you continue to buy and ride out the investments with time weighted averages. Over time, through the ups and downs, after compounded growth, you'll have bought in across the range and be much better off than when you started.

As a young gun, start now, and be methodical. You need two market crashes over the next 20 years and you'll be able to retire as soon as you are ready (Provided you spend less than the average fool).

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Exactly, to get the 7-10% returns requires dollar cost averaging over decades. I've done the math on the raw data myself. With dollar coast averaging you are diversifying your time of entry, so you are diversified in good entry points and bad ones. Historically, the good entry points make up for the bad ones. If you cannot predict ahead of time when an entry point is good or bad (i.e. If you can't time the market) then dollar cost averaging is just saying to hell with it, I'll buy every entry point.

That said, future returns could still be worse, or better, but the past has been anywhere from 6-11% over long periods.

Another thing the OP isn't taking into account with a straight ROI comparison is risk-adjusted returns. Magnitude of returns isn't overly useful when not adjusted for the risk taken to produce the return. You want to maximize returns while minimizing variance.

Btw: Random Walk is a great Texags handle.

To the OP I'll say this.
If you save 15% of your base salary (inclusive of any match given) and put into nothing but the S&P 500 over the next 15 years, you will look up in 15 years and be very happy with where you are in saving for retirement.

There are ways to diversify by splitting domestic/foreign and small/large cap that will do better than just the S&P index, but if you don't want to mess with it you'll still be happy.

The key is never stop buying and you'll be happy where you end up. Time is your biggest friend.

Random walker...There are lots of 15 year periods where you can do better than a 6% mean.

And you'll be longitudinally surprised at how much higher!

Random Walk said:

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"You need two market crashes over the next 20 years and you'll be able to retire as soon as you are ready"

What? LOL

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Random Walkie talkie...you seem to have an equal probability (50/50) of understanding my post. How fitting?

If OP invests now in the up market, and continues through two more 2008-esque crashes over the next 20 years, he'll be sitting pretty.

AND to answer your next question..."sitting pretty" means he will be able to retire in fine fashion as early as he wants.

Nope

I also said 8, not 6. 6 is the mean regression.

Want me to post the data?

https://www.crestmontresearch.com/docs/Stock-Matrix-Index5-11x17.pdf

Excluding dividends and inflation, it doesn't matter the year you started investing, the CAGR regresses to between 6% and a high of 8%.

When adjusted for inflation/dividends/taxes/trading costs, etc, the CAGR is 300-450+ bps lower.

https://www.crestmontresearch.com/docs/Stock-Matrix-Taxpayer-Real1-11x17.pdf

Do you have any empirical data to support that claim?

CAGR from 2000-2010 was roughly -1%.

OK, so lets value line index him across 2 market cycles (1998-2015) [Catches the tail end of the the tech bubble, the dot com crash, tax cuts, start of the Iraq war, Great Recession, TARP, QE1-XXX, ZIRP, Taper Tantrum, Winnowing of Fed Balance sheet)

What was the CAGR? 6.45% with an arithmetic mean of 8.12%.

Regression to the mean has been a powerful statistical phenomena since the advent of descriptive statistics.

If we want to examine a larger data set (1980 - 2016) - 8.01% inflation and dividend adjusted CAGR

If we go back even father (1970 - 2016) - 6.05% inflation and dividend adjusted CAGR

If we go back even father (1871 - 2016) - 6.88% inflation and dividend adjusted CAGR

#Facts

Sequence and order effects along with temporal/time horizon restraints from things like IRA RMDs make this an extremely dangerous statement.

He will be fine IF the sequence of returns is favorable, but if a 2000 or 2008 hits just before he retires/suspends wage earning (-50% equity drop)....

Hence why speaking in absolutes regarding the market is not wise.

If you adjust for dividends inflation trading expenses taxes etc, there are only 4:

1948 - 1963, 1949 - 1964, 1982-1987, 1984-1999.

AND if you kept that money in the market until 2016 you would have....... a 4-6% CAGR.

That's 4 periods out of 100+..... and they all regressed back to the mean.

My apologies if data is wreaking your paradigm

Random Walk said:

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Since 1901, there is no CAGR that's longitudinally above 8%. It doesn't matter what year you use as the base., CAGR regresses to a mean near 6%.

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You are getting way hung up on the data and definitions.

You are looking at inflation and tax adjusted numbers as well. Taxes will vary for each person.

7-11% as stated without inflation or taxes is just as accurate as your linked data sets that account for inflation and taxes. The fact has been reinforced.

Dividends reinvested:

Inflation and tax adjusted CAGR goes to ~6%.

Non-adjusted CAGR is closer to ~9%.

Non-Adjusted are around 6-7%
Adjusted are around 3-5%

First link posted is non-adjusted CAGR. Outside of 2009 - Present, the largest CAGR is 8%. Mean is 6%.

The 1980's - 2000 bull market shifted many investor paradigms to base projection returns of 10%+ . The problem is those returns were from a cyclical bull market that wasn't representative of the entire system. They are the outliers, not the norm.

Random Walk said:

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First link posted is non-adjusted CAGR. Outside of 2009 - Present, the largest CAGR is 8%. Mean is 6%.

The 1980's - 2000 bull market shifted many investor paradigms to base projection returns of 10%+ . The problem is those returns were from a cyclical bull market that wasn't representative of the entire system. They are the outliers, not the norm.

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If technology makes people more productive, can we consider that increased productivity leads to higher profit margins and potentially a permanent shift higher in investment returns?

Or do we always settle at specific number despite productivity, settling on the lowest margin corporate leaders are willing to accept in price wars with competition?