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Investing in Today's Markets

The first thing to understand is how the long term investor, as opposed to the in and out trader, makes money.

Return Equation

This equation says that the same investment producing the same amount of money would be a good investment if you can purchase it at a low price but a terrible investment if you have to pay a high price. Unfortunately, today you have to pay a HIGH price to get investments that produce relatively small amounts of money.

Investment Prices are High Today because There is Too Much Money Chasing too Few Investments

This excess money has two sources.

  1. Central Banks around the world have created massive amounts of money to stimulate the economy after the financial crisis. Unfortunately it wasn't temporary and today the US Federal Reserve has created 5.5 time more money since the financial crisis than there was before it. Worldwide central banks have created 2.4 time more money than exited before the crisis.
  2. The Baby Boom generation is saving for their impending retirement. At about age 50 most people's children have left home and they finally have an opportunity to get serious about saving for their retirement. The peak of the baby boom reached 50 in 2006. The uncertainties created by the financial crisis only added to people's desire to save. Thus, there are even more people with more money looking for a place to invest their money.

What to Do

I council a combination of patience and adjusting one's investment and retirement goals to the current reality.

Benefits of Patience

Prices of financial assets have risen steadily and dramatically since the depth of the financial crisis. Stocks, for example, are up 2.5 times since the bottom during the financial crisis. As always happens, this caused people to buy stocks in the believe that because they have been going up they will continue to go up. Eventually and perhaps it is starting happening now, stocks will go down and these people will sell in fear driving stock prices down further. When that happens you will be able to buy stocks at MORE reasonable prices -- probably not at prices that would give returns like those investors have historically received but still better than today's (start of 2016) returns.

Adjusting one's investment and retirement goals to the current reality

Today, the prices of all assets are so high the returns that you can expect are about half historic figures. After inflation stocks have historically returned about 6%. Expect about 3% in the future. Historically bonds returned about 2% after inflation. Expect about 1%. This in turn means that the standard "balanced portfolio" with approximately equal amounts of stocks and bonds which historically returned 4%. after inflation will return about 2%.

My success as a value investor gives me confidence that I can do better than the returns cited above for the market as a whole but even with this record I do not believe that a return to days when I could plan on geting 8+% a year on my investments will happen for years to come.

Implications for the Futute

Although there is no sign of it now, hopefully central banks will over the next few years withdraw the excess cash that they have created. However, saving by the baby boom generation for retirement will be with us for about 25 more years. Thus, one can not expect a drastic change in the returns you can expect to get from your investments. This in turn means that those in or planning for retirement need to do some combination of saving more and/or reducing their standard of living in retirement. The alternative is to take a BIG risk of outliving your savings.

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