GEK Frederick H. Willeboordse Compound & Prosper!

GEK Financial Markets Lecture 10

GEK Asset classes Historical performance Be critical of numbers, know what they mean. Be aware! The data used in this lecture have not been verified nor are they complete. They are used for illustrative purposes only! Today’s Lecture

GEK Excel Basics – SORT Sorting can be very useful. E.g. if you have a membership list you may want to sort it alphabetically. The sort function can be accessed from the ‘Data’ menu. Select the Cells you’d like to sort. Choose ‘Sort’ from the ‘Data’ menu, select your sorting criteria from the box that pops up and press ‘OK’.

GEK While we have already talked about these, it is important to realize the qualitative difference between them. Cash and Money Markets Bonds Real Estate Stocks The major asset classes are: There are of course other asset classes … some better than others Cards (Pokemon, Baseball) Collections (Coins, Stamps) Art (Paintings, Sculptures) Asset Classes

GEK Asset classes like cards and collections may be excellent but we shall focus here on the ‘financial’ asset classes of stocks, bonds and money markets plus real estate. The main reasons being that theses classes are by far the largest and most liquid and therefore suitable for all investors. Whether or not an asset class is major, its performance will always be benchmarked. Perhaps the most important reference benchmark is inflation. Asset Classes

GEK We already had a look at inflation in the lecture on the time value of money. If we have a 1000 dollars today, we can ask two (equivalent) questions: How many dollars do we need in 25 years to buy the same goods that we can buy now for the 1000 dollars? What are the 1000 dollars worth in 25 years if we keep them stored in our mattress? Asset Classes & Inflation

GEK =FV(D6,H6,0,-D5) =PV(D6,H6,0,-D5) That’s a big amount! In order to get a bit a better idea about the effect of inflation, it is useful to plot a graph. Inflation Revisited

GEK Inflation Revisited

GEK Let’s see what this would mean for a bit a higher rate. Say 24%, the same rate most credit card companies charge you for overdue amounts. Asset Classes & Inflation

GEK Credit cards are a baaaaad idea (if you don’t pay at once)!!!! $0.54 $1,861,054 Yes!!! These are the correct numbers! Your $1000 will be worth 54 cents ! Credit Cards Inflation Revisited

GEK It is also illustrative to see what a change in interest rates means Inflation Revisited

GEK So whatever we do, we need to take inflation into account when comparing the performance of asset classes. Actually, there is no reason to be sad. As such, moderate inflation is not necessarily a bad thing as long as your income growth and/or return on investment can outpace it sufficiently. Asset Classes & Inflation

GEK As mentioned in the lecture on values, risk is an essential issue when evaluating the merits of an investment. Money Market Bonds Stocks Extremely low Very low Medium to Very High Asset ClassRisk Hopefully, this will be reflected in the historical returns. Asset Classes & Risk

GEK Let us have a look at Siegel’s data again. Stocks Bonds Gold Dollar Historical Data

GEK The consumer price index (CPI) is a good proxy for inflation and therefore a closely watched number. A lot of information (for the US) can be found at the website of the bureau of labour: A good page for some useful statistics is: Lets get the average data for most of the past century.average data for most of the past century Historical Data - CPI

GEK How does one get these data into Excel? Fortunately, Excel can open html files. But in older versions, everything ends up in one column. Historical Data - CPI

GEK Use the ‘Text to Columns’ feature in the Data menu, throw out the monthly data and calculate the percentages. =(B3-B2)/B2 That’s better! Historical Data - CPI

GEK Let us compare: =AVERAGE(C3:C88) A big difference! =POWER((B88/B2),1/(A88-A2))-1 =FV($G$4,A88-$A$2,0,-$B$2) =FV($G$3,A88-$A$2,0,-$B$2) Actual Data Compounded with the correct average inflation Rate Compounded with a simple average Historical Data - CPI

GEK What is historical? Which period should one look at? Average Inflation? High Inflation? Low Inflation? Actual CPI Compounded CPI, when compounding with the correct average inflation rate Historical Data - CPI

GEK The Dow Jones is a good reference for the overall performance of the stock market. Dow Jones has a nice website with many data: As does Standard and Poor’s: Historical Data – Dow Jones

GEK The difference between the two periods is very big. These calculations do not take dividends into account. Repeat: Do not blindly trust averages. Historical Data – Dow Jones

GEK Let us see what happens if we take dividend into account Dividend has a significant impact. And of course we should not use the average but the yearly values for the dividend. =D7*(1+C6+$G$16) Historical Data – Dow Jones

GEK Quite a lot of information on bonds can be found at: Historical Data – Bonds

GEK Yield on the 10 year treasury note Historical Data – Bonds

GEK It is illustrative to compare the relative changes: Historical Data – Compared

GEK And the what that means for 1000 dollars: Are stocks really better than bonds? Historical Data – Compared

GEK Once again, the conclusion one can draw from these data depends entirely on one’s perspective. The numbers alone mean little. The interpretation of the numbers must be justified by sound arguments. Understanding is the ONLY way even if it means going through some math! Solely memorizing convenient Excel functions is pointless! Historical Data – Compared

GEK The comparison of data is essential in understanding business data. Know what the numbers mean. The average, e.g., may not be what you think. The three main asset classes have rather different historical performances. Key Points of the Day