The Biased Investor (Part 8)

The Biased Investor (Part 8)

“Nothing ever changes, nothing ever will” – Les Miserables, Herber Kretzmer lyrics

“Fantine,” by Margaret Hall. Source: Wikimedia

Victor Hugo’s Les Miserable is a deeply enriching story of human suffering under various circumstances. It is considered one of the greatest novels of all time. It describes how one man moves from corruption and bestiality to grace and duty—from hell to heaven. Along the way, he interacts with characters moving the other way.

One refrain we hear in the musical version is that the impoverished and desperate circumstances don’t change very much, despite all the efforts of political and spiritual leaders. The revolt of the Paris Uprising of 1832 is violently put down.

It’s a very human tendency to believe that what we have seen lately is what we will continue to experience. We call this “recency bias,” along with “status-quo bias.” Investors look at the returns of the stock market for the past 50 years – 9.6% with dividends reinvested – and they assume that these returns can be repeated. But not all half-centuries are created equal. For the 50 years ending in 1980, US stocks returned less than 5%.

Returns from all asset classes—stocks, bonds, real estate, commodities—have been turbocharged since 1980 by falling interest rates. The price of any asset is the present value of all its future cash flows. If you decrease the discount rate—the interest rate used to determine the present value—the assets are worth more. Yields go down, asset values go up. In 1980 30-year US Treasury bonds yielded 11.3%. If you bought a long-term zero-coupon bond back then, your money grew over 30 times through 2010. But inflation was 12.5% in 1980. If that had continued, your money wouldn’t have grown at all, in real terms. inflation has fallen dramatically though, goosing returns.

30-year stock market total return: US, Japan, Inflation. Source: Bloomberg

Markets aren’t magic. They don’t provide excess returns just by sprinkling the pixie dust called risk over our savings so that we can retire comfortably. Returns come from economic growth. Just look at Japan. While the US was providing 7.6% real annualize returns over the past decade, the Japanese stock market has only eked out 0.4% returns. But it sure didn’t start out that way. We were all “turning Japanese” back in 1990.

Our limited perspective makes it seem like things never change. And to be honest, we don’t want them to change. Change can be threatening. But circumstances are always evolving, adapting to new techniques and technology. Human nature doesn’t change. But as markets adjust, we need to adjust our expectations.

Douglas R. Tengdin, CFA

Chief Investment Officer

By | 2017-07-17T12:21:55+00:00 June 10th, 2016|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. –
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