Author Topic: People say you don't lose in the stock market if you hold on long enough...  (Read 4460 times)

SeattleCPA

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I've been graphing a bunch of the data from the "Rate of Return of Everything" study for a blog post. (That data is available here, http://www.macrohistory.net/data/#DownloadData, and easily massaged with MS Excel.).

It's really interesting to see when and why stock markets have failed to deliver positive returns over long periods of time: France, Portugal, Japan, etc.

Totally recommend anyone who's an Excel user and student of investing to noodle around with the available data:

BTW, as an example, I tried to chart the investment balance if someone in France had invested in stocks, housing and bonds using a red line for the stocks, a green line for the rentals and then a purple line for the bonds. Here's what the graph looks like... you can't even see the red "stocks" line because it lies flat and beyond the purple bonds line:


PDXTabs

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I assume that is inflation adjusted.

Is that with or without dividends reinvested?

BicycleB

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Stocks and bonds there yielded negative returns for 90 years!? Wow!

I wonder what % of France's investment market the different categories were in 1919, and what the overall return of investing an amount (say 100,000 francs) at that time would eventually have been.

I think I've read somewhere France had some of the worst returns. I guess not surprising after a tough WW1 and worse WWII.

Can the graph be adjusted so that negative returns are visible? (I'm assuming that the "flat" line conceals negative returns; would be curious to see them.)

SeattleCPA

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I assume that is inflation adjusted.

Is that with or without dividends reinvested?

Those are real returns and include appreciation and dividends.

SeattleCPA

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Stocks and bonds there yielded negative returns for 90 years!? Wow!

I wonder what % of France's investment market the different categories were in 1919, and what the overall return of investing an amount (say 100,000 francs) at that time would eventually have been.

I think I've read somewhere France had some of the worst returns. I guess not surprising after a tough WW1 and worse WWII.

Can the graph be adjusted so that negative returns are visible? (I'm assuming that the "flat" line conceals negative returns; would be curious to see them.)

Here's the way I should have done the chart ... with logarithmic scaling. (I've actually updated the blog's chart in this manner)


Paul der Krake

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Well, to put things in perspective for people with only a passing knowledge of French history: World War I killed roughly 5% of the French population of the time. And it's not like the war killed the population indiscriminately. Instead, it mostly wiped out young men in the prime of what would have been their prime working years. Imagine what that does to your economic prospects as a country. Then once you're barely getting back on your feet, WWII breaks out.

If you stick to the post-war period, things look a lot better:



(taken from https://en.wikipedia.org/wiki/CAC_40 which is the French equivalent of the S&P500)


Indexer

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Even in the US about half of stocks are flat or lose money over time according to a recent research paper from Vanguard looking at 30 years of data, from 87 to 17. A few companies saw a lot of growth and that's why the average returns are so good for US stocks over that time.


That said, what's a big highly successful French company? I can't think of one.  I'm sure there are a few, but there are also likely plenty of losers pulling down the averages.


Sounds like a good argument for global diversification instead of concentration in one or a few countries. There will be successful companies with good ideas who will see amazing growth, but where will they be?  I don't know, so I'll index and buy them all.


@Paul der Krake:  All good points. In addition, while I'm not an expert on all of the details of the topic I know they did go pretty far towards Socialism after WWII. When I say Socialism, I don't mean free healthcare , I mean the government was taking over the means of production (private companies) in order to guarantee jobs. That would also likely explain why it took until the late 70s / early 80s for the markets to start rising again.
« Last Edit: June 24, 2019, 09:12:44 PM by Indexer »

ysette9

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Even in the US about half of stocks are flat or lose money over time according to a recent research paper from Vanguard looking at 30 years of data, from 87 to 17. A few companies saw a lot of growth and that's why the average returns are so good for US stocks over that time.


That said, what's a big highly successful French company? I can't think of one.  I'm sure there are a few, but there are also likely plenty of losers pulling down the averages.


Sounds like a good argument for global diversification instead of concentration in one or a few countries. There will be successful companies with good ideas who will see amazing growth, but where will they be?  I don't know, so I'll index and buy them all.


@Paul der Krake:  All good points. In addition, while I'm not an expert on all of the details of the topic I know they did go pretty far towards Socialism after WWII. When I say Socialism, I don't mean free healthcare , I mean the government was taking over the means of production (private companies) in order to guarantee jobs. That would also likely explain why it took until the late 70s / early 80s for the markets to start rising again.
I donít know about how well they perform financially, but Iíve heard of all most of the top 20:
https://fr.m.wikipedia.org/wiki/Classement_des_plus_grandes_entreprises_franÁaises_en_2017

caleb

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if someone in France had invested in

Wait, what's to prevent someone living in France from investing in the S&P 500 or the FTSE or the Nikkei?

Seems like the problem isn't being French, it's putting all your eggs in a single, smaller country basket over a period where that country is rapidly divesting itself of its former colonies while insisting on the standard of living formerly subsidized by those colonies.

Yes, some countries shrink and are downwardly mobile over time.  That's not really news.  In general, global capitalism has not had that problem over anything but very short periods of time.  On a global scale, capitalism tends to grow in value and produce dividends.

ysette9

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Good point. That is why Iím invested globally.

Paul der Krake

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Even in the US about half of stocks are flat or lose money over time according to a recent research paper from Vanguard looking at 30 years of data, from 87 to 17. A few companies saw a lot of growth and that's why the average returns are so good for US stocks over that time.


That said, what's a big highly successful French company? I can't think of one.  I'm sure there are a few, but there are also likely plenty of losers pulling down the averages.


Sounds like a good argument for global diversification instead of concentration in one or a few countries. There will be successful companies with good ideas who will see amazing growth, but where will they be?  I don't know, so I'll index and buy them all.


@Paul der Krake:  All good points. In addition, while I'm not an expert on all of the details of the topic I know they did go pretty far towards Socialism after WWII. When I say Socialism, I don't mean free healthcare , I mean the government was taking over the means of production (private companies) in order to guarantee jobs. That would also likely explain why it took until the late 70s / early 80s for the markets to start rising again.
There aren't new sexy high tech companies like Google or Tesla, and may never be any. Major issues in the labor market that make it unlikely. Let's just say that there is a good chunk of the population that rejects the very idea of a market economy.

But there are huge companies, often created from the ashes of what used to be public companies. BNP Paribas is a good example. Up until the 90s it was just a low key public institution. Then it was privatized and started acquiring other banks left and right, consolidating market share and gaining influence. In the US it only owns two small regional banks, but as whole it's a juggernaut, larger than both Wells Fargo and Bank of America.

Also present on the list that ysette linked to earlier: Renault and Peugeot, they're unknown in North America but are massive companies selling millions of cars every year on multiple continents.

BicycleB

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I find this post thought provoking. I don't think it just automatically affirms our standard advice. I think it should make us think harder.

The data that we assume as our main reference points didn't exist then. The data that, in looking backwards, will make today's mistakes obvious may not exist yet either. In each case, the question is "what wise decision is logical using the knowledge of the time, in ways that can be replicated today with similar results." In 1919, from the graph presented, I assume that French houses in the aftermath of the Great War and a huge plague had very low values. I kind of doubt "buy a global basket of stocks" was a natural thing for the casually prosperous everywoman amidst the battered French countryside. I remember reading how 1919 involved giant strikes in which occupied Germans resisted French occupation by blocking coal shipments or something. What was that time's equivalent of today's "buy VTSAX and maybe a little VTSAX"? It probably wasn't "buy a lot houses that nobody wants", but that was the best technique.

In retrospect, buying some cheap houses would have been a great investment. But if they appeared to be logically super-cheap, who would have had the wisdom and capacity to buy them? What is today's equivalent of such a wise purchase? I kind of doubt that VTIAX is as cheap now as French houses then. Is the lack of obvious equivalent simply because we're not at a similar point in history? Even if so, is there something we should learn besides "our standard plan is fine, even though people in the past failed with something similar"?

It could be argued that the French case suggests "diversify across multiple asset categories, including something undervalued". Or "including real esate". Does that mean own rental property, or just a home? Or does it mean "buy commodities, because everybody hates them, which makes them like French houses in 1919"?

« Last Edit: June 24, 2019, 10:59:18 PM by BicycleB »

SeattleCPA

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If you stick to the post-war period, things look a lot better:


I don't know... using the full France returns data set and adjusting for inflation, the real return since 1965 runs about 3% for French equities... which is about the same as French bonds. 3% is better than zero but equity investors didn't get much "risk premium."

BTW, absolutely not a student of French economic history, and I've lost it now, but I had read as part of my blog post on this stuff that privatization of big companies and then the 1970s oil shock hit France hard.

Tip: Click the chart to see a bigger, legible version...
« Last Edit: June 25, 2019, 07:06:18 AM by SeattleCPA »

SeattleCPA

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I find this post thought provoking. I don't think it just automatically affirms our standard advice. I think it should make us think harder.

The data that we assume as our main reference points didn't exist then. The data that, in looking backwards, will make today's mistakes obvious may not exist yet either. In each case, the question is "what wise decision is logical using the knowledge of the time, in ways that can be replicated today with similar results." In 1919, from the graph presented, I assume that French houses in the aftermath of the Great War and a huge plague had very low values. I kind of doubt "buy a global basket of stocks" was a natural thing for the casually prosperous everywoman amidst the battered French countryside. I remember reading how 1919 involved giant strikes in which occupied Germans resisted French occupation by blocking coal shipments or something. What was that time's equivalent of today's "buy VTSAX and maybe a little VTSAX"? It probably wasn't "buy a lot houses that nobody wants", but that was the best technique.

In retrospect, buying some cheap houses would have been a great investment. But if they appeared to be logically super-cheap, who would have had the wisdom and capacity to buy them? What is today's equivalent of such a wise purchase? I kind of doubt that VTIAX is as cheap now as French houses then. Is the lack of obvious equivalent simply because we're not at a similar point in history? Even if so, is there something we should learn besides "our standard plan is fine, even though people in the past failed with something similar"?

It could be argued that the French case suggests "diversify across multiple asset categories, including something undervalued". Or "including real esate". Does that mean own rental property, or just a home? Or does it mean "buy commodities, because everybody hates them, which makes them like French houses in 1919"?

So above comments really resonate to me. My conclusions after reading the "rate of return of everything" study and then also after going elbow deep in the data is (a) stay sober about the risks and (b) consider increasing real estate investments.

BTW, I've got 14 line charts for 14 countries you can see them all here, Rate of Return of Everything Line Charts, but since you mentioned above Germany:



The obvious thing that jumps out here... that hyperinflation Weimar Republic experienced absolutely destroyed the long-run bond returns.
« Last Edit: June 25, 2019, 01:46:40 PM by SeattleCPA »

CorpRaider

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Interesting, will check out your post. 

I've seen the data/publications from Professor Elroy Dimson, et. al. that (I think) Credit Suisse publishes every year (and in book triumph of the optimists).  I think they point to hyper inflation Germany leading to nationalist takeover (followed by war decimation and 50% communist rule) and of course the communist nationalizations in Russia, China, etc...as sort of worst case outcomes observed to date in history.  Even worse than France or Japan from 1988 (or whatever). i.e., 0% > -100%.  I also caught Dimson on some podcasts and other talks and the impression I filed away was basically "the RE data is kind of trash because it doesn't account for maintenance cap ex or other sustaining expenditures (like property tax).

Definitely another reason why I'm moderately concerned about the "I've been investing since 2009 and history shows 100% VTI is the best portfolio" crowd.
« Last Edit: June 25, 2019, 10:21:46 AM by CorpRaider »

SeattleCPA

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Interesting, will check out your post. 

I've seen the data/publications from Professor Elroy Dimson, et. al. that (I think) Credit Suisse publishes every year (and in book triumph of the optimists).  I think they point to hyper inflation Germany leading to nationalist takeover (followed by war decimation and 50% communist rule) and of course the communist nationalizations in Russia, China, etc...as sort of worst case outcomes observed to date in history.  Even worse than France or Japan from 1988 (or whatever). i.e., 0% > -100%.  I also caught Dimson on some podcasts and other talks and the impression I filed away was basically "the RE data is kind of trash because it doesn't account for maintenance cap ex or other sustaining expenditures (like property tax).


A couple of comments... first, and for the record, I'm a long-time cheap stock funds guy. I'm not a real estate fanatic... (I am using the David Swensen asset allocation formula... but hey that's 70% equities...)

Second, the criticisms of the "direct real estate investment" option that one hears from people like Ken Fisher and other professionals selling investment advice seem a little subjective. The "rate of return of everything" study authors did count expenses... well except for property taxes which they estimate subtract about 1% a year in some cases. (Even with this adjustment, across the 16 countries, housing looks like a better deal.) Also I sort of think the "expenses" on stock investments are pretty light, too, prior to things like no-load mutual funds... and even right up until the time of Vanguard's nearly free index funds. And clearly the stock returns don't subtract a 1% investment advisor fee...

An example of Ken Fisher's comments: https://www.usatoday.com/story/money/2019/06/09/retirement-savings-shouldnt-depend-real-estate-profits/1359794001/

Definitely another reason why I'm moderately concerned about the "I've been investing since 2009 and history shows 100% VTI is the best portfolio" crowd.

Me too brother... me too.

« Last Edit: June 25, 2019, 11:09:48 AM by SeattleCPA »

bacchi

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The difficulty of real estate, compared to mutual funds, is location, location, location. Picking up some retail or housing in a small town in France wouldn't have worked out so well in the past 20-30 years.

https://www.thelocal.fr/20190610/analysis-why-throwing-money-at-frances-dying-towns-isnt-the-answer
https://www.nytimes.com/2017/02/28/world/europe/france-albi-french-towns-fading.html

Quote from: nytimes
A survey of French towns found that commercial vacancies have almost doubled to 10.4 percent in the past 15 years.

The retail is still there, of course, but people go to the right-outside-of-town shopping centers now.

Getting diversification in equities is much easier, when considering single point of failure, than getting diversification in real estate.

CorpRaider

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@SeattleCPA thx for response. 

You didn't come off as a RE fanatic. 

I have to admit that every time I hear one of these RE magnates speak I think "this guy seems like a complete moron....maybe I should get into real estate."  hah!

SeattleCPA

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The difficulty of real estate, compared to mutual funds, is location, location, location. Picking up some retail or housing in a small town in France wouldn't have worked out so well in the past 20-30 years.

https://www.thelocal.fr/20190610/analysis-why-throwing-money-at-frances-dying-towns-isnt-the-answer
https://www.nytimes.com/2017/02/28/world/europe/france-albi-french-towns-fading.html

Quote from: nytimes
A survey of French towns found that commercial vacancies have almost doubled to 10.4 percent in the past 15 years.

The retail is still there, of course, but people go to the right-outside-of-town shopping centers now.

Getting diversification in equities is much easier, when considering single point of failure, than getting diversification in real estate.

@bacchi ... good additional sources. Thanks!

Two other comments just to throw into the discussion "hopper"... first, curiously, housing overall in France did deliver a decent return. So all the stuff that hammered stocks didn't in the end hammer real estate the same way.

And this second comment: The "rate of return of everything" study authors did point out that if you're buying a single property in a particular locale your risks maybe resemble the risk of buying equities.

FWIW, I have tried to find data that lets one estimate how many different locations/zip codes/etc one would need to dial down the unsystematic risk. But that's probably not something I should admit in public... Especially since I haven't been able to find the right data or do the math.

habaneroNorway

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Even the last 20 years or so the performance of vast parts of the European equity markets has been rather abysmal in real terms. And for an european, its not really that strange to have put the vast majority of investments in the Euro-zone than it is for an US-based investor to put most in US markets - after all, the Eurozone is a very big economy. In the era of ultra-low interest rates in the Eurozone bonds have also outperformed equities.

As a fun fact, the 100y (yes, a hundred year bond) issued by Austria has gained 35% since the start of this year alone. That is a rather spectacular performance for a government bond. Thy also have one maturing in 2062 which was issued in 2012 (so 50 years back then). This has returned over 100% since it was issued in addition to the coupons paid to investors.

thesis

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Definitely another reason why I'm moderately concerned about the "I've been investing since 2009 and history shows 100% VTI is the best portfolio" crowd.

Me too brother... me too.

This reminds me of the phrase, "Everyone is a genius in a bull market". Although I'm not particularly concerned about it, it is interesting to think about the bigger picture.

What's not mentioned here, as far as I have seen, is the fact that French houses may have been a great investment at that time, but that's only if they weren't being bombed to shit. Not sure if the study considered that or not... (also I'm lazy).

Granted, the US leans more socialist these days, but this is always a matter of degree with any country. We have a history of innovation, but we also have a large population to draw from. I'm not concerned.

My personal bias is to be annoyed by the "buy real estate" crowd, but it's good to note that not every stock market has made comparable returns to the S&P index over the past decade, or even toward its inception.  Real estate has its own risks, namely the cost of maintenance because it's subject to physical degradation. But I will concede that there are times and places where it's probably made the most sense as an investment vehicle. This just is not de facto, "jklol real estate is da best". Historical, social, and political circumstances all play a role. I'd love to see this explored more, but as others have stated, "diversify" is probably your best bet

HMman

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I find this post thought provoking. I don't think it just automatically affirms our standard advice. I think it should make us think harder.

The data that we assume as our main reference points didn't exist then. The data that, in looking backwards, will make today's mistakes obvious may not exist yet either. In each case, the question is "what wise decision is logical using the knowledge of the time, in ways that can be replicated today with similar results." In 1919, from the graph presented, I assume that French houses in the aftermath of the Great War and a huge plague had very low values. I kind of doubt "buy a global basket of stocks" was a natural thing for the casually prosperous everywoman amidst the battered French countryside. I remember reading how 1919 involved giant strikes in which occupied Germans resisted French occupation by blocking coal shipments or something. What was that time's equivalent of today's "buy VTSAX and maybe a little VTSAX"? It probably wasn't "buy a lot houses that nobody wants", but that was the best technique.

In retrospect, buying some cheap houses would have been a great investment. But if they appeared to be logically super-cheap, who would have had the wisdom and capacity to buy them? What is today's equivalent of such a wise purchase? I kind of doubt that VTIAX is as cheap now as French houses then. Is the lack of obvious equivalent simply because we're not at a similar point in history? Even if so, is there something we should learn besides "our standard plan is fine, even though people in the past failed with something similar"?

It could be argued that the French case suggests "diversify across multiple asset categories, including something undervalued". Or "including real esate". Does that mean own rental property, or just a home? Or does it mean "buy commodities, because everybody hates them, which makes them like French houses in 1919"?

So above comments really resonate to me. My conclusions after reading the "rate of return of everything" study and then also after going elbow deep in the data is (a) stay sober about the risks and (b) consider increasing real estate investments.

BTW, I've got 14 line charts for 14 countries you can see them all here, Rate of Return of Everything Line Charts, but since you mentioned above Germany:



The obvious thing that jumps out here... that hyperinflation Weimar Republic experienced absolutely destroyed the long-run bond returns.

The housing line there doesn't make sense to me. I can see how the massive hyperinflation wrecked bond yields, but what caused the housing to suddenly bounce back after being dragged down? Was there massive hyperdeflation in the housing market circa 1958? Or maybe a data integrity issue of some sort?

SeattleCPA

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What's not mentioned here, as far as I have seen, is the fact that French houses may have been a great investment at that time, but that's only if they weren't being bombed to shit. Not sure if the study considered that or not... (also I'm lazy).

I think they consider that. I.e., the housing return looks at the country's entire housing stock. So houses being "bombed to shit" gets considered... just as businesses and factories getting "bombed to shit" gets considered.

...it's good to note that not every stock market has made comparable returns to the S&P index over the past decade, or even toward its inception.

So the key observation of the "rate of return of everything" study is that housing in the majority of economies beats equities. And curiously, it does basically because housing returns show less volatility.

That's not true for all economies and hasn't been true in the US (see line chart below).



But most often, apparently, housing has beat equities. Commonly, returns look like those in Sweden (see below):



BTW, the blog post with the 14 line charts (see here) is basically a "children's book" version of the full study... Mostly pictures with relatively few words...

SeattleCPA

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I find this post thought provoking. I don't think it just automatically affirms our standard advice. I think it should make us think harder.

The data that we assume as our main reference points didn't exist then. The data that, in looking backwards, will make today's mistakes obvious may not exist yet either. In each case, the question is "what wise decision is logical using the knowledge of the time, in ways that can be replicated today with similar results." In 1919, from the graph presented, I assume that French houses in the aftermath of the Great War and a huge plague had very low values. I kind of doubt "buy a global basket of stocks" was a natural thing for the casually prosperous everywoman amidst the battered French countryside. I remember reading how 1919 involved giant strikes in which occupied Germans resisted French occupation by blocking coal shipments or something. What was that time's equivalent of today's "buy VTSAX and maybe a little VTSAX"? It probably wasn't "buy a lot houses that nobody wants", but that was the best technique.

In retrospect, buying some cheap houses would have been a great investment. But if they appeared to be logically super-cheap, who would have had the wisdom and capacity to buy them? What is today's equivalent of such a wise purchase? I kind of doubt that VTIAX is as cheap now as French houses then. Is the lack of obvious equivalent simply because we're not at a similar point in history? Even if so, is there something we should learn besides "our standard plan is fine, even though people in the past failed with something similar"?

It could be argued that the French case suggests "diversify across multiple asset categories, including something undervalued". Or "including real esate". Does that mean own rental property, or just a home? Or does it mean "buy commodities, because everybody hates them, which makes them like French houses in 1919"?

So above comments really resonate to me. My conclusions after reading the "rate of return of everything" study and then also after going elbow deep in the data is (a) stay sober about the risks and (b) consider increasing real estate investments.

BTW, I've got 14 line charts for 14 countries you can see them all here, Rate of Return of Everything Line Charts, but since you mentioned above Germany:



The obvious thing that jumps out here... that hyperinflation Weimar Republic experienced absolutely destroyed the long-run bond returns.

The housing line there doesn't make sense to me. I can see how the massive hyperinflation wrecked bond yields, but what caused the housing to suddenly bounce back after being dragged down? Was there massive hyperdeflation in the housing market circa 1958? Or maybe a data integrity issue of some sort?

The data is available from the macrohistory website linked to in first post... but what's happening with Germany housing returns is they "disappear" around the time the Nazis come to power... and then show up later. (I also wonder if maybe the partitioning of Germany factors into local researchers' return data.)

Kind of a related note: I didn't include line charts for Japan or Portugal due to similar only worse problems... For those countries, the line charts look like roller coaster tracks.

talltexan

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It seems intuitive that stocks outperform housing in US and no other country: we have vast land areas that can be developed for new housing, as well as several of the most dynamic businesses in the world.

thesis

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What's not mentioned here, as far as I have seen, is the fact that French houses may have been a great investment at that time, but that's only if they weren't being bombed to shit. Not sure if the study considered that or not... (also I'm lazy).

I think they consider that. I.e., the housing return looks at the country's entire housing stock. So houses being "bombed to shit" gets considered... just as businesses and factories getting "bombed to shit" gets considered.

Ok, that's good :)

SeattleCPA

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It seems intuitive that stocks outperform housing in US and no other country: we have vast land areas that can be developed for new housing, as well as several of the most dynamic businesses in the world.

Stocks outperform housing in about a third of the countries and then housing outperforms stocks in the remaining two-thirds.

BTW, in UK, stocks beat housing...

But in Finland (which has been massively influenced by the often stellar performance of Nokia) housing has done better.

So it's a tricky riddle to solve.

BTW the other thing is, even in the US, housing arguably would have done good things to your portfolio. E.g., the 1966 scenario that causes retiree portfolios to fail with a 4% SWR? Real estate protects an investor from that.

The correlation coefficient is, like, 2. or .3... though that's a fuzzy number...

Radagast

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I've been thinking about selling the house (now fully rental) because it is a lot of work. Then something like this comes up and I'm like ....well....

SeattleCPA

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I've been thinking about selling the house (now fully rental) because it is a lot of work. Then something like this comes up and I'm like ....well....

@Radagast, I think the same way. And I respectfully argue that thinking this way makes TONS of sense..

I'm struck by a couple of threads active at Bogleheads right now... One thread, shepherded by the longtime and respected Boglehead @Siamond is discussing the "rate of return of everything" study and some folks including Siamond are thinking aloud about how and whether the study's data should influence people's ideas about portfolio construction. Thoughts like "more international" and "gosh maybe real estate does merit consideration..."

Another thread discusses whether people should hold rental property... and one thing happening in that thread is a horde of anti-real-estate-investment folks and mostly Monday morning quarterbacks are coming up with a long list of reasons for not investing in real estate.

But what I keep thinking about all of this is, does an allocation to rental property strengthen someone's portfolio? E.g., applying modern portfolio theory logic, does X% of rental property mean the safe withdrawal rate goes up? Or that the risks go down?

I think the data suggests it does.

And then, to re-frame this in terms of some of the discussions you see over at Bogleheads, what's the better choice... using a 3% or 3.5% safe withdrawal rate so you "get through" a 1966 scenario? Or having a duplex that requires a couple of hours a week but lets you use a 4% or 4.5% safe withdrawal rate.


bacchi

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But what I keep thinking about all of this is, does an allocation to rental property strengthen someone's portfolio? E.g., applying modern portfolio theory logic, does X% of rental property mean the safe withdrawal rate goes up? Or that the risks go down?

I think the data suggests it does.

Yes, agreed. The % is fairly low, I would expect, before locale risk becomes too much of a concern.

Quote
And then, to re-frame this in terms of some of the discussions you see over at Bogleheads, what's the better choice... using a 3% or 3.5% safe withdrawal rate so you "get through" a 1966 scenario? Or having a duplex that requires a couple of hours a week but lets you use a 4% or 4.5% safe withdrawal rate.

Having a rental with decent tenants is easy. It's when you get crappy tenants in there that it becomes a PITA.

Could a REIT replace all or some of the real estate exposure? VNQ market correlation is no higher than 0.8 and sometimes as low as 0.5.

SeattleCPA

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But what I keep thinking about all of this is, does an allocation to rental property strengthen someone's portfolio? E.g., applying modern portfolio theory logic, does X% of rental property mean the safe withdrawal rate goes up? Or that the risks go down?

I think the data suggests it does.

Yes, agreed. The % is fairly low, I would expect, before locale risk becomes too much of a concern.

Quote
And then, to re-frame this in terms of some of the discussions you see over at Bogleheads, what's the better choice... using a 3% or 3.5% safe withdrawal rate so you "get through" a 1966 scenario? Or having a duplex that requires a couple of hours a week but lets you use a 4% or 4.5% safe withdrawal rate.

Having a rental with decent tenants is easy. It's when you get crappy tenants in there that it becomes a PITA.

Could a REIT replace all or some of the real estate exposure? VNQ market correlation is no higher than 0.8 and sometimes as low as 0.5.

So people using David Swensen's asset allocation formula (people like me) put 15% into REITs basically as an inflation hedge. (Swensen, as many here but not everybody here maybe knows, suggests 30% allocation to real assets like REITs and TIPS to protect investors against a bad inflation scenario. Like 1966.)

If REITs do the trick, I am all for REITs. That would be easiest.

It looks to me, though, like REITs show more correlation with, e.g., US equities than direct real estate investment does. Direct real estate investment shows maybe a .2 or .3 correlation.

And then, if you want to just flail away at this notion just a bit more, what if someone owns their own home... do the investment qualities (or the inflation hedging) intrinsic to home ownership immunize your portfolio?

BicycleB

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It looks to me, though, like REITs show more correlation with, e.g., US equities than direct real estate investment does. Direct real estate investment shows maybe a .2 or .3 correlation.

And then, if you want to just flail away at this notion just a bit more, what if someone owns their own home... do the investment qualities (or the inflation hedging) intrinsic to home ownership immunize your portfolio?

I think these are things people should think about, but answers are hard (non-obvious). Thoughts in no particular order:

Low correlation is good for portfolio diversification, aka safety. Right?

Re the benefits and risks of a single property, or property in one locale: I think there's huge variation between individual markets, so viewing in % withdrawal rate terms may be unwise. We need to recognize that a property is a big gamble. You win, the effect is similar to a high withdrawal rate if you can solve liquidity issues. You lose, it's similar to a very low withdrawal rate for your whole portfolio, assuming that the property in question is a significant % of the original portfolio. Generally, my guess is that the variance is bigger than is accounted for in withdrawal rate calculations, so the risk is higher.

I do think that cash-out or liquidity issues are big deal in a single property or a small number of rentals. Very different from REITs. Then again, there's whole lot I don't understand about REITs.

My overall guess is that diversifying into real estate is a blunt instrument. It's powerful, but varies widely in its effect depending on details of the investment. So it's hard to generalize.

Fwiw, in my own market, I've observed that during downturns, rentals stay full when people hesitate to buy. So it looks like my rental property (I mean, the 3/4 of my house that is used as rental) has a countercyclical safety factor. Probably not generalizable though...
« Last Edit: June 27, 2019, 04:17:22 PM by BicycleB »

NorCal

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This reminds me of a presentation I saw from a hedge fund manager about a decade ago.  This particular hedge fund focused on short-selling.

The info is dated, and I don't remember the specific numbers.  The presentation had a graph with two lines.  The first was the return on the S&P 500 from 1980 to 2007 (when the presentation was).

The second line was the return on the S&P 500 if you bought all of the S&P 500 stocks in 1980 and held those specific companies until 2007.  That is, you would never add new growing companies to the list, and you would never trim your holdings of companies kicked out of the index.

The S&P 500 was up several hundred percent over that time period.
The S&P 500 v.1980 had lost something like 50% or 70% of its value.

It's really amazing how growth is centralized in a very small number of companies / countries.

DavidAnnArbor

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Maybe the Vanguard REIT index correlates more closely with equities than a residential home is because the REIT includes a lot of commercial property that is rented or to be rented by corporations.

bacchi

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Maybe the Vanguard REIT index correlates more closely with equities than a residential home is because the REIT includes a lot of commercial property that is rented or to be rented by corporations.

Good point. REZ is a residential ETF that has 0.32 correlation with the S&P.

https://www.etfscreen.com/corrsym.php?s=REZ

Its expenses are high but not obscenely; of course, we know that residential can go off the rails, too.

Radagast

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@Radagast, I think the same way. And I respectfully argue that thinking this way makes TONS of sense..

I'm struck by a couple of threads active at Bogleheads right now... One thread, shepherded by the longtime and respected Boglehead @Siamond is discussing the "rate of return of everything" study and some folks including Siamond are thinking aloud about how and whether the study's data should influence people's ideas about portfolio construction. Thoughts like "more international" and "gosh maybe real estate does merit consideration..."

Another thread discusses whether people should hold rental property... and one thing happening in that thread is a horde of anti-real-estate-investment folks and mostly Monday morning quarterbacks are coming up with a long list of reasons for not investing in real estate.

But what I keep thinking about all of this is, does an allocation to rental property strengthen someone's portfolio? E.g., applying modern portfolio theory logic, does X% of rental property mean the safe withdrawal rate goes up? Or that the risks go down?

I think the data suggests it does.

And then, to re-frame this in terms of some of the discussions you see over at Bogleheads, what's the better choice... using a 3% or 3.5% safe withdrawal rate so you "get through" a 1966 scenario? Or having a duplex that requires a couple of hours a week but lets you use a 4% or 4.5% safe withdrawal rate.
I think the "Talmud" portfolio seems like a great idea. 1/3 in land, 1/3 in business, 1/3 in reserve. I think a person who put 10x expenses in each of those categories would absolutely coast through an early retirement without a concern in the world. I don't have enough money yet myself, but if/when I think about leaving my job a few decades early that would be a leading contender in the asset allocation department. In my head I divide each of those into 5 categories, for example 5 cashflowing  properties in diverse areas, five stock slices or other definitions of "business,"  five definitions of "reserves." Overkill maybe. Anywho I already own rental real estate whose price is (about) equally driven by the national real estate market and the price of gold, so I got that box checked. Now I need residential RE catering to farming, "growth," and some other sectors.

I think it obviously makes your finances more secure, especially if you have nothing better to do with your time. Safe withdrawal rate is the only measure of risk I find useful, so SWR vs. risk is two kids on the same side of the teetertotter.

If my duplex took two hours a week I would have sold it. I get better money at my job.

Radagast

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Could a REIT replace all or some of the real estate exposure? VNQ market correlation is no higher than 0.8 and sometimes as low as 0.5.
I doubt it. First there are a lot of general businesses there, which reflect the stock market and economy. Residential real estate reflects the fact the people need somewhere to live.

In fact REITs are included in Vanguard Total Stock Index. In general I think it is good to have something that is not part of "the market," any market, because markets can do odd things at any time for no predictable reason, and anything traded on "the market" can lose its value at the same time simply because it is part of "the market." To me VNQ would not be the same thing as individual housing units for that reason, but it might be good enough.

And then, if you want to just flail away at this notion just a bit more, what if someone owns their own home... do the investment qualities (or the inflation hedging) intrinsic to home ownership immunize your portfolio?
Absolutely it does. Somebody in your France graph who retired in 1919-1970 and lost essentially all other assets could have put a reverse mortgage on their home (today, anyhow, but probably then with the right banker), lived in one room, and rented out the rest of the house to a young person/family for the cost of food, maintenance, and care. Totally a winning strategy. This also explains why I would probably only ever consider buying a home with two units or which could easily be separated into two units. Heck with the only house I bought so far I had plans to wall off the stairs and turn the basement into a third unit if I lost my job, providing me enough money to subsist after paying the mortgage. That line of thinking probably has something to do with graduating college in December 2008 in one of the worst hit cities.

SeattleCPA

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It's really amazing how growth is centralized in a very small number of companies / countries.

@NorCal , interesting thought and good point.

Sorta connected, at some point, gosh, maybe decades ago, I had a Lotus 1-2-3 spreadsheet full of individual stock returns data.

I'd read and re-read Burton Malkiel's "Random Walk Down Wall Street" enough times to know that, what, with 20-25 stocks I could build a portfolio that largely eliminated unsystematic risk. So I set to work, thinking, it'd be an interesting project to build my personal own index fund. Surely a good magazine article...who knows, maybe even a book in there someplace?

Like so many other quixotic ideas, this one quickly floundered when it encountered reality. The problem? In those days, you couldn't get the market return unless you included one of the then superstar stocks like Dell Computer or Microsoft.

SeattleCPA

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Maybe the Vanguard REIT index correlates more closely with equities than a residential home is because the REIT includes a lot of commercial property that is rented or to be rented by corporations.

@DavidAnnArbor , That's interesting thought... and a good one.

I'm not sure this a good thought, but also along that line of thinking I've wondered if REITs being easily traded also means they behave more like stocks. This thought might also be the same thing as saying that direct real estate investment only appears less risky than stocks and possibly traded REITs because people aren't getting real time valuations, aren't buying and selling through the day.

SeattleCPA

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I think the "Talmud" portfolio seems like a great idea. 1/3 in land, 1/3 in business, 1/3 in reserve....

That's really interesting, isn't it? I mean, that two thousand plus years ago, thoughtful people had figured out you want to diversify among asset classes...

If my duplex took two hours a week I would have sold it. I get better money at my job.

But this would depend on our portfolio size, right? E.g., and keeping the math easy, if you or I pick up an extra 1% in SWR with the duplex, our portfolio size drives our hourly effective earnings.

With $200K portfolio, you're talking $2000 a year of extra withdrawals, a bonus for the 104 hours of work. That's about $19 an hour.

With a $2M portfolio, you're talking $20,000 a year of extra withdrawals as the bonus... and that's about $190 an hour.

I'm all in at $190 an hour. I already watch too much streaming video.


SeattleCPA

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Could a REIT replace all or some of the real estate exposure? VNQ market correlation is no higher than 0.8 and sometimes as low as 0.5.
I doubt it. First there are a lot of general businesses there, which reflect the stock market and economy. Residential real estate reflects the fact the people need somewhere to live.

In fact REITs are included in Vanguard Total Stock Index. In general I think it is good to have something that is not part of "the market," any market, because markets can do odd things at any time for no predictable reason, and anything traded on "the market" can lose its value at the same time simply because it is part of "the market." To me VNQ would not be the same thing as individual housing units for that reason, but it might be good enough.

This is what I was trying to say earlier in my response to @DavidAnnArbor . I think you've said it better here.

And then, if you want to just flail away at this notion just a bit more, what if someone owns their own home... do the investment qualities (or the inflation hedging) intrinsic to home ownership immunize your portfolio?
Absolutely it does. Somebody in your France graph who retired in 1919-1970 and lost essentially all other assets could have put a reverse mortgage on their home (today, anyhow, but probably then with the right banker), lived in one room, and rented out the rest of the house to a young person/family for the cost of food, maintenance, and care. Totally a winning strategy. This also explains why I would probably only ever consider buying a home with two units or which could easily be separated into two units. Heck with the only house I bought so far I had plans to wall off the stairs and turn the basement into a third unit if I lost my job, providing me enough money to subsist after paying the mortgage. That line of thinking probably has something to do with graduating college in December 2008 in one of the worst hit cities.

So that's interesting too. And for US investors looking at the 1966 scenario, it looks like owning a home would have provided a ton of protection. At least for some localities. (Not sure about places like Detroit ... or small towns in agricultural communities losing population.)

SeattleCPA

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Re the benefits and risks of a single property, or property in one locale: I think there's huge variation between individual markets, so viewing in % withdrawal rate terms may be unwise.

@BicycleB that's a good point. And in the rate of return of everything study, they actually highlight this point, saying:

"...both individual housing returns and those of individual equities show a higher volatility than the aggregate indices. For example, we found that in the U.S., local (ZIP5) housing return volatility is about twice as large as aggregate volatility, which would about equalize risk-adjusted returns to equity and housing if investors owned one undiversified house."

BTW, very quickly in my mind, your comment and the study authors' similar comment makes me wonder, gosh, how many zip codes do you need to be "in" before you dial down the unsystematic risk...

And then I hear the echo of @NorCal 's remark about the hedge fund guys observations concerning S&P 500 returns. And at that point, I realize maybe I've fallen down the rabbit hole.