From Chapter 14

Research on Safe Withdrawal Rates

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JWR1945
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From Chapter 14

Post by JWR1945 »

Chapter 14 of our featured book, Common Sense on Mutual Funds by John Bogle, talks about compounding and time and how a small difference in returns, given enough time, can build up to a very large difference in the final balance. This completes his four dimensions of investing: reward, risk, cost and time. He is quick to point out that time greatly reduces the overall risk and magnifies the effect of persistent costs.

He describes the effect of time on one's reward as the magic of compounding. He describes the reduction of risk with time as the moderation of compounding. He describes the effect of time of even a small persistent cost as the tyranny of compounding.

Much of what John Bogle presents is familiar including the rule of 72. [To a good approximation, an investment doubles when the product of the number of years and the percentage interest rate equals 72. The approximation is especially good when both the number of years and the percentage interest rates are between 7 and 10.]

There is one comment on page 310 that I wish to draw attention to. Although the normal range of risk falls off rapidly and is narrow, the extremes remain wide. At 15 years, the middle two-thirds (i.e., plus and minus one standard deviation) of returns fall between 3.4% and 10.3%. The extremes were -1.4% and +14.2%. [Figure 14.4 apparently uses the same data as Figure 1.3. If so, the years involved were 1802-1997.]

Have fun.

John R.
peteyperson
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Re: From Chapter 14

Post by peteyperson »

I've never found the rule that useful because it ignores the effect of inflation. The result then becomes pretty meaningless.

I do however look at Buffett's goal of a 15% annualised nominal return which after accounting for 5% inflation (avg based on govt stats since 1970), would release 10% real. And 10% real would double an investment every 7 years. So I do keep that one in my head but finding a business whose earnings will compound up at a rate of 15% is very difficult and at present market prices one needs to factor in a PE multiple contraction to various degrees to be prudent. This reduces the likelihood still further. But I still like the odds better than acting like a "know-nothing" investor and buying an index fund, crossing my fingers and hoping. That stuff is only for the birds. :shock:

Sidebar: Whilst finding a business that compounds sales & earnings up by 15% is difficult, one can find businesses that compound at lower rates but have sufficiently lower capital expenditure requirements to be able to use some of the retained earnings for share buybacks and still deliver the required earnings growth. This can boost the earnings per share beyond what would normally be expected. Coca Cola has done this for some years and both Coke and Pepsi are presently performing this function which is helping to increase their 5% slowed growth to a 9-10% earnings per share growth from buybacks and a further 1-2% dividend (Coke 2%, Pepsi 1.7% pre-tax), giving a total return of 10-11% in what is expected to be a lousy market that doesn't deliver a historical 10% return no more... Coke is also a good example of a company that once was a long-term buy and hold but many sold out in the late 90s due to management problems that persisted. Coke has just done another management shuffle to try to solve the problems, whom now have to contend with a move away from soda pop to still drinks include water, a saturated US market and the Atkins low carb fad which is affecting the growth of all food & beverage companies of late. I don't envy them. Right now, Pepsi is doing far better as a more diversified but regretably more US based business.

Petey
JWR1945 wrote:Chapter 14 of our featured book, Common Sense on Mutual Funds by John Bogle, talks about compounding and time and how a small difference in returns, given enough time, can build up to a very large difference in the final balance. This completes his four dimensions of investing: reward, risk, cost and time. He is quick to point out that time greatly reduces the overall risk and magnifies the effect of persistent costs.

He describes the effect of time on one's reward as the magic of compounding. He describes the reduction of risk with time as the moderation of compounding. He describes the effect of time of even a small persistent cost as the tyranny of compounding.

Much of what John Bogle presents is familiar including the rule of 72. [To a good approximation, an investment doubles when the product of the number of years and the percentage interest rate equals 72. The approximation is especially good when both the number of years and the percentage interest rates are between 7 and 10.]

There is one comment on page 310 that I wish to draw attention to. Although the normal range of risk falls off rapidly and is narrow, the extremes remain wide. At 15 years, the middle two-thirds (i.e., plus and minus one standard deviation) of returns fall between 3.4% and 10.3%. The extremes were -1.4% and +14.2%. [Figure 14.4 apparently uses the same data as Figure 1.3. If so, the years involved were 1802-1997.]

Have fun.

John R.
JWR1945
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Post by JWR1945 »

I do however look at Buffett's goal of a 15% annualised nominal return
As a sidebar: our brokers in the United States almost always project a 15% total return for their investment recommendations. This seems to be the magic number that maximizes commissions.

Have fun.

John R.
peteyperson
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Post by peteyperson »

Well Buffett has said to be wary of high predictions. Better to have a management and products of quality and then you can get a slower substainable growth rate and prudent share buybacks that can deliver a high return. Some investors can make the mistake of using a high growth rate to justify buying in at especially high PEs. Dell is a good example of that, PE 33, growing 20% a year still, beating all comers thru better management of processes and taking market share. But when the dust settles in 5-10 years and they are in a Microsoft dominant position in hardware, where will the PE settle to and what will be the annualised return? Less easy to figure out, so excellent company but not necessarily an excellent investment at these prices (it is on my review list to delve further but I am not optimistic). Growing too fast can cause business problems, excessive debt etc. Even Dell ran into this problem I think in 1992.

Petey
JWR1945 wrote:
I do however look at Buffett's goal of a 15% annualised nominal return
As a sidebar: our brokers in the United States almost always project a 15% total return for their investment recommendations. This seems to be the magic number that maximizes commissions.

Have fun.

John R.
th
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Post by th »

JWR1945 wrote:
I do however look at Buffett's goal of a 15% annualised nominal return
As a sidebar: our brokers in the United States almost always project a 15% total return for their investment recommendations. This seems to be the magic number that maximizes commissions.

Have fun.

John R.
Or the magic number thats not too high to pull the "bullshit" lever, but high enough to intrigue.
He who fights with monsters might take care lest he thereby become a monster. And if you gaze for long into an abyss, the abyss gazes also into you. - Nietzsche
JWR1945
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Post by JWR1945 »

Exactly right, th.

Have fun.

John R.
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