I have just finished reading Edward O Thorps autobiography A Man For All Markets which is an excellent little read and a good addition to any traders library. In the book Thorp talks about he value of compounding returns. There is no doubt that success is trading or investing is based upon compounding your gains over the long term. Compounding is a wonderful tool in that what seem to be small quanta of difference can over time lead to an enormous difference in returns. For example an investment with a return of 10% compounded annually for 10 years yields $259,374 whereas the same investment compound at 11% yields $283,942. Extend the holding time to 20 years and the figures becomes $672,750 and $806,231 respectively. Time is the key to compounding and this is a point Thorp makes, he also makes the important point that most lack the patience to do this.
However, there is a sting in the tale of compounding that I have noticed that those on the sell side of the business either abuse or simply do not understand and that is one of scale. You will often see very long term charts of an index or an instrument and it shows a wonderful upward trajectory (well you wouldn’t show things that didn’t work) and the message is that you simply have to hold for whatever the requisite time is and you will eventually have a small pot of gold. The key word here is eventually because what is often overlooked is the time to achieve these mythical gains. There is no doubt at all that compounding is a very powerful tool and when combined with consistency and patience achieves remarkable things.
However there is always a but we need to be aware of. To demonstrate this I found a centuries worth of data on the All Ords and using $1 as the starting investment plotted what the return would be over the next 116 years.
If you had started with $1 in 1900 and simply let the compounding returns of the index take its course you would have $487,801.23. At first glance this is quite impressive – the markets very long term rate of return sits at about 9% and if you let it do its thing for a long period of time then you get an impressive number at the end. However, there are two things to be aware of in viewing this data. Firstly, the time taken to achieve your goals, not only is the time itself a problem but the erosion of the value of your investment over time is a problem. I had a cursory look for long term inflation data but couldn’t find much dating back beyond the 1940’s but if you assumed an average inflation rate of 4% then this puts a large hole in the real end value of your investment. The second issue that is not addressed is the trajectory of the journey – the chart above is not of a capital guaranteed term deposit but of an index. The somewhat linear trajectory of the graph is deceiving since it does not take into account the extended and deep bear markets that were experienced. There were years when the market went nowhere and these events are testing for even the most hardened buy and hold advocate.
Time is both the ally and enemy of those who understand how to use compounding and it is this dualism that we need to be aware of. The practical implication of this is to leave your money in your trading account for as long as possible before taking it out and spending it. The impact of large withdrawals is quite remarkable in the damage it does to accounts but some people cannot resist spending in the short term to ensure they live in poverty in the long term
The most precious commodity in life is TIME. We never have enough of it.
I personally squandered a lot of time in my twenties and thirties doing all sorts of random things. I was just busy being busy.
It wasn’t until I turned 40 that I realized a couple of big things about TIME.
Here’s a simple idea that made my life simpler and created time:
Find the key 20% in anything I do that is key.
Focus and execute well on that key 20%.
Completely ignore the rest.
More here – What I Learnt On Wall Street
In the past few decades, the fortunate among us have recognised the hazards of living with an overabundance of food (obesity, diabetes) and have started to change our diets. But most of us do not yet understand that news is to the mind what sugar is to the body. News is easy to digest. The media feeds us small bites of trivial matter, tidbits that don’t really concern our lives and don’t require thinking. That’s why we experience almost no saturation. Unlike reading books and long magazine articles (which require thinking), we can swallow limitless quantities of news flashes, which are bright-coloured candies for the mind. Today, we have reached the same point in relation to information that we faced 20 years ago in regard to food. We are beginning to recognise how toxic news can be.
More here – The Guardian
It is no secret that I am not a fan of fund managers of any kind, be they the more exotic style of hedge fund that exists as an idiot tax for those who invest in them, the standard vanilla equity investment fund or the legally mandated rip off that are superannuation funds. My objection is simple, if you are going to take billions in fees from people then you had better deliver something other than perpetually under performing the market. In a puff piece that looked somewhat like a marketing exercise Morningstar the ratings agency has named the top investment funds in Australia and the list was picked up by Fairfax and covered here. I have copied the list of top funds below.
Source – Fairfax
The article talks about the value of investing in the number one ranked fund since it has outperformed the index over the last 10 years – this point got me thinking about using 10 years as a point of comparison and the notion of starting points in general. As a general point I find selecting 10 years interesting since it makes certain that the funds are compared against the index during and post the GFC and it doesn’t take a genius to work out that the average return from the index since that time has been poor.
I decided to have a deeper look at the impact of starting times upon portfolios by digging up some data on the All Ordinaries Accumulation Index which is now referred to as Total Return Index since it includes the return from both gains in the index and dividends. Starting in 1960 I looked at what your average return would be to the present day if you had started investing at a given point. For example if you had invested in an index linked fund in 1960 your average return up until the present date would have been 13.53% whereas if you had begun your investment journey in 1994 your average return would be 9.99%. This might not seem to be a substantive difference but over time it adds up to a small fortune.
What interested me when I looked at this data was the remarkably consistent nature of the returns – they are all positive. Whilst, this is to be expected it is nonetheless interesting that the index doesn’t put together strings of negative years and this is shown in the raw data that I will look at later. What is also evident is that there seems to be a tailing off in average returns which is more obvious when this data is plotted as a chart.
The reason for this drop off can be found in the raw data as shown below. This data is the true return for the index for each year in the sample.
In this table I have highlighted each year where the return was over 25%. You can see a cluster of such returns in the 1970’s and 1980’s with a drop off in 1990 and 2000 and since 2010 there has not been such a year. In performance outliers count disproportionately and when they are lacking things look bleaker. I have no real explanation as to the rationale for the drop off in returns although I would surmise it may be simply due to a lack of funds flowing into the market due to the real estate boom. My recollection of the lift in 1991 and 1993 where due in part to the pent up recovery in the market post the 1987 crash but also that real estate struggle under the regime of high interest rates so we had an asset rotation underway.
Despite this drop off in returns over the past decade there is still no compelling reason to buy a managed fund. However, it is important to note that these are average returns over deep time – it in no way diminishes the importance of not being in the market when the market has nothing to give you. What also amazes me about fund managers is that they believe timing is so hard when in fact with simple mechanical rules it is remarkably easy as I have already demonstrated here using the ETF STW. Trading is only as hard as you make it or in the case of fund managers it is only as hard as you want to make it appear.
Most self-help books make exhausting demands of their readers. The endless list-making and inventorying. The frequent deployment of the encomium “Yay, you!” The tacit assertion that “journey” has not been overexposed as a result of the “Don’t Stop Believin’” glut. It’s easy to conclude, why can’t someone just write a self-improvement book called “Canceling Lunch” and be done with it?
Cynics, take heart. A new literary genre, which might be called anti-self-help or anti-improvement, is upon us.
Granted, reading a book that coaches you on how to reject self-help is like downing a shot of Patrón to get the nerve to stop drinking. But it appears to be working. Both “A Counterintuitive Guide to Living a Good Life,” by Mark Manson, and Sarah Knight’s “How to Stop Spending Time You Don’t Have With People You Don’t Like Doing Things You Don’t Want to Do” were best sellers. (Those are the subtitles. The titles use a pointedly vulgar phrase synonymous with “not caring one bit.”)
Now comes one of the better-written entries in the genre, “Stand Firm: Resisting the Self-Improvement Craze,” which made its author, Svend Brinkmann, a psychology professor in Denmark, a media star there.
More here – The New York Times