A.I.M. Users Bulletin Board

[ls7550]

I heard a speech from a fellow with a doctorate in Economics

This is a link to a blog by a guy who has a fair bit of economic knowledge

http://www.brookings.edu/blogs/ben-bernanke/posts/2015/03/30-why-interest-rates-so-low

Thanks Tom for the heat map you posted in http://investorshub.advfn.com/boards/read_msg.aspx?message_id=112335980

Interesting to also look at the data from a real (inflation adjusted) perspective IMO. I usually take the easy route and just subtract inflation (more strictly its a divisor function, but subtractions of yearly values is reasonable close).

If a asset broadly paces inflation in a volatile manner and drops -5% one year when inflation is 5%, then the next year it has to gain +15% to get back to break-even in real (inflation adjusted) terms.

Whilst cash and gold ...etc are elementary assets, similar to unworked land where the price of the land might broadly rise with inflation over time, other assets are compound assets (stocks etc.) which are more like worked land i.e. the land price rises with inflation whilst produce of the worked land are sold and provide a dividend.

For a compound asset (i.e. stocks) that provides a 5% dividend in a 5% inflation world and has the share price broadly rise by inflation, then after a -5% nominal drop, -10% real after inflation is factored in and its average is a +5% real total gain - then it needs to hit a +25% nominal next year gain in order to fit that model.

-5% nominal (-10% real) one year
+25% nominal (+20% real) the next year
+20% nominal (+10% real) combined two year gain in reflection of 5%/year inflation and comparable to inflation rate dividend.

i.e. for a asset such as stocks that broadly yields a 5% annualised real reward, that asset might be nominally down -5% one year, up +25% the next. The data in the table you posted somewhat reveals such tendencies.

Typically geometric compound averages are less than the arithmetic average. -5% one year, +25% the next has a geometric annualised average of 9% whilst the arithmetic yearly average is 10%. When you hold a diverse range of assets and rebalance the tendency is to uplift the geometric average closer to the arithmetic average.

For two assets that cycles through -5% one year, +25% the next and individually provide +5% real gains, and the two assets tend to move counter direction to each other, one down -5% one year, the other asset up +25% that same year and vice-versa the second year then 50/50 weighting both and rebalancing yearly captures a higher portfolio benefit than holding either alone. Individually compound -5% nominal one year, +25% nominal the next = +18.75% two year annualised gain. Compound 50% in one asset that is down -5% one year, up +25% the next with 50% in a asset that is up +25% one year, down -5% the next and the portfolios two year annualised gain is +21% i.e. a 2.25% higher two year annualised gain.

If you toy around with such calculations then for example 50/50 elementary asset (cash) and compound asset (stocks) yearly rebalanced produces a 15.5% two year annualised, which is relatively close to the 18.85% annualised from 100% in a single compound asset alone. At 66/34 stock/cash you start to see portfolio annualised gains that are quite close to 100% in stocks alone - but typically with less portfolio risk (volatility).

UBH and the likes are in effect exploiting such characteristics. More stocks than cash (bonds), rebalancing and low/inverse correlations etc helping to provide gains via price appreciation, income (dividends/interest etc.) and volatility capture (rebalance benefits). That can broadly compare to single asset gains - but that typically has lower risk (portfolio volatility).

If you want to maximise potential rewards then holding multiple compound assets with no/low/inverse correlations and rebalancing is the better choice. Such as large cap, small cap, domestic, foreign, worked land (or home and accounting for the imputed rent benefit) ... etc.

For satisfactory rewards with less risk, adding some elementary assets (cash, bonds, gold) into the mix and the portfolio volatility (risk) is reduced whilst that portfolios total gains might still compare to a single compound assets gain.

Cogs and wheels all churning as Lichello so eloquently put it.