No. of Recommendations: 23
What I am trying to understand is why something that is only expected to be approximately right over indefinite but long periods of time is of serious interest. I am not managing a university endowment. My second twenty-year window as a serious investor is about half over, and most of us only get two.
It's probably far more important information for individuals than for endowments.
The single most important number for anyone's retirement planning is the likely expected real return from the portfolio in question. Imagine this sort of observation provides you with a rational expectation of (say) inflation plus 0-2%/year in the next 15 years. You would then have two rational choices: plan your retirement expenditures to that low number, or invest in a different way. Simply saying you want to assume ever greater market valuation levels, the only way you'd get historically typical returns from here from the broad US equity market, is not an approach I would recommend.
Sticking with the Bogle style is a perfectly rational choice and I don't mock anyone in that camp. But they should have their eyes wide open: the result is highly dependent on the starting point.
When SPY was introduced in early 1993, it was a great thing: it helped a lot of people do well. And it wasn't particularly overvalued or undervalued at the time, a nice bonus. The S&P 500 index has risen inflation + 5.81%/year since then, a fine result (plus the dividend yield has averaged 1.91% since then). But one can't ignore the fact that the VALUE of the S&P 500 index has only risen 3.65%/year since then (smoothed real earnings), despite the amazing upswing in net profit margins. The other 2.16%/year of index rise has been from multiple expansion. If the index had risen only the same amount as trend earnings since then, the S&P index would be 3058 today, about half today's level.
So, we now know that a period of ~32 years of valuations rising at ~2.2%/year is possible. Would it be possible for valuations to fall at ~2.2%/year for 32 years? Sure. Besides, it has happened before. That's not a prediction, but it's something that one might need to be prepared for.
Jim
