hocus2004 wrote:I understand. I'm not going to take all of my money and stick it in an S&P index fund because of the numbers that have been put forward in this thread. There are indeed other asset classes that are generally more attractive.
But it's possible that seeing these numbers could influence me to put a small percentage of my portfolio in an S&P index fund.
Here are the relevant 30-year numbers.
Year, 1923-1972 Calculated 30-Year Return, Upper Confidence Limit, Lower Confidence Limit
Code: Select all
1995 5.82 7.82 3.82
1996 5.44 7.44 3.44
1997 5.23 7.23 3.23
1998 5.03 7.03 3.03
1999 4.79 6.79 2.79
2000 4.72 6.72 2.72
2001 4.89 6.89 2.89
2002 5.14 7.14 3.14
2003 5.58 7.58 3.58
Today's Calculated 30-Year Return would be only slightly more than that of 1997. It would be less than that of 1996.
Here are the relevant 15-year numbers.
These are my calculated values of the 15-year returns. I have added 5% for a confidence limit on the high side. I have subtracted 5% for a confidence limit on the low side.
Year, Calculated 15-Year Return, Upper Confidence Limit, Lower Confidence Limit
Code: Select all
1995 3.21 8.21 (1.79)
1996 1.99 6.99 (3.01)
1997 1.30 6.30 (3.70)
1998 0.64 5.64 (4.36)
1999 (0.14) 4.86 (5.14)
2000 (0.38) 4.62 (5.38)
2001 0.19 5.19 (4.81)
2002 0.99 5.99 (4.01)
2003 2.43 7.43 (2.57)
Today's S&P500 index is close enough to 1134.41 to suggest that today's projections are similar to, but slightly higher than, those of 1997 and lower than those of 1996.
The 30-year numbers (i.e., annualized real return with all dividends reinvested) led hocus2004 to ponder:
Your number for the most likely 30-year real-return starting from today's valuation level is about 5.3 percent and the range of possibilities goes from 3.3 to 7.3. Assume an investor..who does not expect to retire for at least 30 years. Is it fair to say that, while this investor might obtain better results by keeping a good portion of his money out of stocks until prices return to more moderate levels, he would not be doing something all that terrible to put a good portion of it in stocks so long as he is absolutely certain that he possesses the inner strength to keep the same percentage in stocks through some severe price drops?
Looking at the 30-year results, the answer is yes. Today's situation is very similar to 1997 and slightly more favorable. This supports making plans based on a return of 5.3% plus and minus 2%.
Now consider a more realistic investor:
Say that this individual would like to put 10 percent or 20 percent or perhaps even 30 percent of his portfolio in stocks. But he can't be taking wild risks because he depends on the income streams generated by his investments to provide for himself and his family. Say that he is confident that, even if stock prices were to fall 90 percent, he would not lower his stock allocation so long as stocks comprised only 20 percent of his portfolio and so long as he knew that the historical data supported his long-term return expectations.[Emphasis added]
His dependence on income streams changes everything. We need to look at the 15-year numbers.
There is a tremendous amount of uncertainty at year 15. Using the 1997 results as representative of today's situation, this retiree is looking at a return with all dividends reinvested of 1.3% plus and minus 5% at the halfway point (i.e., year 15 while planning for 30 years). His actual return will be less because he is making withdrawals. He does not reinvest all of his dividends. His 15-year balance is less than 1.3% plus and minus 5%.
There is a good chance that he will have a loss at year 15 even if he makes no withdrawals. The downside risk, even if he reinvests all of his dividends, is (3.7%), that is, minus 3.7%. The upside potential at year 15 is 6.3%, but only if he makes no withdrawals.
Withdrawing a portion of the dividends to provide an income stream is similar to selling stock. Without withdrawals, reinvested dividends are deposits. With withdrawals, the failure to reinvest all of the dividends reduces the amount of these deposits. This is not exactly the same thing as selling shares. But it is similar.
I have determined the annualized real returns with and without reinvesting dividends at year 15. For 1929, the annualized real return with all dividends reinvested was 1.34%. With none of the dividends reinvested, the annualized real return was a loss, (3.38%) at year 15. For 1965, the annualized real return with all dividends reinvested was a small loss, (0.68%) at year 15. With none of the dividends reinvested, the annualized real return was (4.31%). For 1967, the annualized real return with all dividends reinvested was (0.86%). With none of the dividends reinvested, the annualized real return was (4.71%).
[Looking at the opposite extreme, for 1949 the annualized real returns were 13.77% and 9.43% with and without reinvested dividends. For 1985, the annualized real returns were 14.28% and 11.61%, respectively.]
Judging from these numbers, a failure to reinvest dividends reduces the annualized real return by (approximately) 3% at year 15. This changes our retiree's outlook at today's valuations to (1.7%) plus and minus 5% at year 15.
Would you tell this poor befuddled soul that the historical data indicates that he can pretty much count on a 3.3 percent real return at the end of 30 years, that it is likely that he will get 5.3 percent, and that there is a long-shot chance that he might even get as much as 7.3 percent?
No. Here are some numbers at year 30. [Actually, here are too many numbers.]
The annualized real returns for 1929 were 6.57% with dividends reinvested and 0.93% with dividends removed. For 1965, the annualized real returns were 4.01% with all dividends reinvested and 0.38% with no dividends reinvested. For 1967, the annualized real returns were 5.70% with all dividends reinvested and 2.12% with all dividends removed. There were no instances with a loss at year 30 with all dividends removed in the modern era (i.e., post 1921). There were several periods with losses prior to that. Losses at year 30 were never so bad as (2%).
For 1949, the annualized real returns were 6.70% with all dividends reinvested and 2.79% with no dividends reinvested. Data for 1985 does not extend to 30 years. For 1933, the annualized real returns were 9.78% with all dividends reinvested and 4.70% with all dividends removed. For 1943, the annualized real returns were 9.29% with all dividends reinvested and 5.26% with all dividends removed. [This was the highest return with all dividends removed.]
I would identify the range of annualized real returns in the (recent) historical record as 0% to 5% when dividends are removed (to supply an income stream). The corresponding range of returns with all dividends reinvested is 4% to 10%. I have not made projections for today's valuations with all dividends removed. Using the 1929, 1965 and 1967 returns as a rough guide, the range of annualized real returns would be 4% to 6% with all dividends reinvested and 0% to 2% with all dividends removed.
[We can compare these values of 4% to 6% with dividends reinvested in 1929, 1965 and 1967 with the (more accurate) projections of 3.3% plus and minus 2% in recent years. Projections using today's valuation are likely to be 2% less than the numbers that I have presented. With all dividends removed, the most likely real annualized return at year 30 would be a loss of (1%).]
Back to the original question:
Would you tell this poor befuddled soul that the historical data indicates that he can pretty much count on a 3.3 percent real return at the end of 30 years, that it is likely that he will get 5.3 percent, and that there is a long-shot chance that he might even get as much as 7.3 percent?
No. I would tell him that he should be prepared for a loss of buying power equal to (1%) plus and minus 2% if he uses all dividends for income. [ERROR: He should expect an annualized gain of 3.3% plus and minus 2% only if he reinvests all of the dividends.] CORRECTION: He should expect an annualized gain of 5.3% plus and minus 2% only if he reinvests all of the dividends.
This is one of our best threads ever, JWR1945. Thanks once again for your willingness to hang in there so long..You are a PATIENT Numbers Guy..
Thank you for your kind words. It is very easy to be patient when my calculations are likely to help real people. In addition, these exchanges are interesting. They have brought many things to my attention that I had not realized before.
Have fun.
John R.