Comments on: Why people invest in stocks A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: gummy Thu, 20 May 2010 10:35:28 +0000 I understand that “gurus” (normally) associate higher returns with higher volatility — and would sigh (with some disgust) at the results of the questionnaire.

But what are the (historical) facts?

Investors are schmarter than you think :^) el/Returns%20vs%20Volatility

By: centralplains Thu, 20 May 2010 03:31:48 +0000 I’m not sure where Felix gets his “feeling” that people invest in stocks to have a chance to solve their financial problems, I personally invest in stocks because I see opportunity for better returns than cash or bonds. In my experience people who are not active investors/traders don’t have the knowledge or discipline to be effective investors. I find this particular blogger to be snobbish and cynical about markets and trading in general. It must be nice to be so “smart” to avoid such dangerous opportunities.

By: MGabel Wed, 19 May 2010 20:27:37 +0000 Most “investors” complicate the investment process, use poor judgment and succumb to emotions to distract themselves from achieving their long-term financial goals.

Most fail to realize that it is their behavior, rather than short-term market performance, that will have the most effect on their achieving their goals. Some fail to start early enough. Some fail to invest enough. Many sell out of fear in troubled times and buy back overconfidently after rebounds. Fads are chased and “expert advice” is taken from those who know nothing of the person’s situation, time horizon or investment goals.

These behavioral mistakes explain why most are not financially wealthy.

By: JoeyNatomas Wed, 19 May 2010 14:18:28 +0000 Winstongater,

There is a smarter portfolio approach that places heavy emphasis on safety of principal, liquidity and income, yet simultaneously provides investors with compelling potential for capital appreciation (that also embraces your preference for small caps)… d-portfolio-theory/

By: tcolemanuf Wed, 19 May 2010 02:23:19 +0000 Felix,
I did a quick and dirty calculation using the S&P500 and a a simple EMA trendline.

Daily Return Above Trendline
Min -6.87%
Max 5.12%
Avg 0.09%
Median 0.08%
Std Dev 0.78%

Once the trendline is broken to the downside the markets become much more volatile

Daily Return Below Trendline
Min -20.47%
Max 11.58%
Average -0.09%
Median -0.08%
Std Dev 1.38%

You can see the daily return standard deviation jumps by 60 bps.

Now this isn’t a total return calculation so there are no dividends incorporated here but just based on the the prices. However, investing below the EMA trendline turns $1 invested into $0.02, meanwhile investing only above the trendline turns the $1 into $663.93.

Tends to back up your asset allocation model you posted on the other day, where as the volatility increases it is time to wade out of the markets. Need some more time to play with it to decide if volatility is causing lower returns or as momentum fades it increases the volatility.

By: BlackBox Wed, 19 May 2010 00:45:15 +0000 Some of the points in the discussions of “equity premium” appear to be inconsistent, because return is treated as an abstract number. The problem is that there is no way that any price discount at a single point in time can relate to a perpetual difference in annual return. For example, if you thought that stocks ought to trade at a discount of 10%, say, because of the “equity premium”, then you should expect that discount not just today, but next year as well, so it should not affect your expectation of any capital component of total returns. The only component of stock returns which should be affected by a price discount is the dividend yield, and that by a small amount because a 10% discount makes a 10% change in the dividend yield, say from 2% to 2.2%.

The main permanent difference between stocks and bonds is that stocks represent ownership of a share of the economy and the average capital component of stock returns should, on the whole, follow the economy. If the size of the economy grows then the diversified stock owner goes along for the ride. Of course, he is also strapped into his seat on the downswing when the economy shrinks.

The growth in the size of the economy is not directly comparable with a fixed dollar return on a bond, which is why the classic advice to have some of each makes sense. But neither one should be expected to return more than a few percent per year.

By: TFF Wed, 19 May 2010 00:32:21 +0000 Why don’t you believe there is an equity premium? Is that not evident on its face?

TIPS yield less than 2% right now. Top consumer companies with steady businesses and AAA credit ratings yield 3% or more right now. Both payouts (and values) are likely to rise with inflation, however the consumer products company is also likely to profit somewhat from investing its retained earnings on expansion into new markets.

Top quality stocks ought to beat inflation by 4% over the long run. Investment-grade bonds can likely beat inflation by about half of that. There is absolutely a premium for investing in stocks, nor is it clear to me that the investment is any riskier. (More volatile, for sure, but you admit that is distinct from long-term risk.)

We are at the END of a period in which bonds have performed almost as well (or better) than stocks — at least if you stayed away from arcane mortgage securities. However these things tend to be cyclic. Bond yields are ridiculously low right now, and any increase in yield will take its toll on the sale value. Stocks are also expensive, historically speaking, but less so than bonds.

I do agree that the siren song of massive wealth drives SOME segments of the stock market to irrational heights, however there are other segments that are predictable, relatively stable, and consistently profitable. You won’t get wealthy from such investments, but you absolutely will outperform bonds.

By: cjkubx Tue, 18 May 2010 22:50:34 +0000 “in questionnaires investors tended to have higher return expectations when they forecast volatility as being relatively low, and lower return expectations when they forecast higher volatility.”

In the short and medium term this makes perfect sense. If we expect volatility to go down then we can expect valuations to go up and so we can expect that returns on what equities we currently own will be high during the climb up. In the term of decades it’s a different story, share buybacks will be purchasing equities at too high prices for too long.

Felix, you recently cited and praised an article by Jeremy Siegel on P/E ratios, which described how earnings can be considered as the equivalent of dividends (currently at ~7%). Do you really understand the article and implications? Those earnings can be used for dividends, share buybacks, investments and paying down debt. In fact,theoretically, the options besides dividend payouts should increase shareholder value as much or more than dividends.

By: HBC Tue, 18 May 2010 19:45:51 +0000 A more interesting question would be: Why Do Good People Invest in Bad Stocks?

And then try to do something about it.

By: winstongator Tue, 18 May 2010 19:36:13 +0000 I invest in stocks precisely because of the volatility, and prefer small cap stocks because of their inherently higher volatility. A single stock 100X’ing in value – going from 1B mkt cap to 100B, or 100M to 10B – from a small company to a large one, makes up for a lot of losers – 100% go bankrupt losers. It’s also what investing is supposed to be about – giving people money to grow their business.

Where people go wrong is pulling out of stocks after a down stretch in a period of high volatility. They miss the upswing after eating the downswing.