Asset Classes & Financial Markets
Lecture 11
This lecture is part of Chapter 5:
Becoming a Millionaire
Today’s Lecture
Asset classes
Historical performance
Be critical of numbers,
know what they mean.
Be aware! The data used in this lecture have not been verified
nor are they complete.
They are used for illustrative purposes only!
Asset Classes
While we have already talked about these, it is important to
realize the qualitative difference between them.
The major asset classes are:
• Cash and Money Markets
• Bonds
• Real Estate
• Stocks
There are of course other asset classes … some better
than others
• Cards (Pokemon, Baseball)
• Collections (Coins, Stamps)
• Art (Paintings, Sculptures)
Asset Classes
Asset classes like cards and collections may be excellent but
we shall focus here on the ‘financial’ asset classes of stocks,
bonds and money markets plus real estate.
The main reasons being that theses classes are by far the
largest and most liquid and therefore suitable for all
investors.
Whether or not an asset class is major, its performance will
always be benchmarked. Perhaps the most important
reference benchmark is inflation.
Asset Classes & Inflation
We already had a look at inflation in the lecture on the time
value of money.
If we have a 1000 dollars today, we can ask two (equivalent)
questions:
• How many dollars do we need in 25 years to buy the
same goods that we can buy now for the 1000 dollars?
• What are the 1000 dollars worth in 25 years if we keep
them stored in our mattress?
Inflation revisited
A
2
3
4
5
6
7
8
9
10
11
12
13
14
15
B
C
D
E
F
G
H
I
Inflation
Present Value
Inflation
1,000.00
4.80%
Dollars needed to buy the same:
Worth in present dollars:
In this many years
$3,228.73
$309.72
25
=FV(D6,H6,0,-D5)
=PV(D6,H6,0,-D5)
That’s a big amount! In order to get a bit a better idea about
the effect of inflation, it is useful to plot a graph.
Inflation revisited
A
B
C
D
E
F
G
H
I
J
K
L
2
3
Inflation
4
5
Present Value
1,000.00
6
Inflation
4.80%
7
8
Numbers of Years
1
5
10
15
20
25
30
35
9
Worth in present dollars:
$954.20
$791.03
$625.73
$494.97
$391.54
$309.72
$245.00
$193.80
10
Dollars needed to buy the same:
$1,048.00 $1,264.17 $1,598.13 $2,020.32 $2,554.03 $3,228.73 $4,081.68 $5,159.94
11
12
The money grows on trees act
The disappearing money act
13
14 $1,200.00
$6,000.00
$1,000.00
$5,000.00
$800.00
$4,000.00
$3,000.00
$600.00
$2,000.00
$400.00
$1,000.00
$200.00
$0.00
$0.00
0
0
5
10
15
20
25
30
35
40
10
20
30
40
Asset Classes & Inflation
Let’s see what this would mean for a bit a higher rate.
Say 24%, the same rate most credit card companies charge
you for overdue amounts.
Credit cards are a baaaaad idea (if you don’t pay at once)!!!!
Inflation
revisited
Credit Cards
A
2
3
4
5
6
7
8
9
10
11
12
13
14
Yes!!!
These
areF the correct
numbers!
C
D
E
G
H
I
Your $1000 will be worth 54 cents!
B
Inflation
Present Value
Inflation
K
L
$0.54
1,000.00
24.00%
Numbers of Years
Worth in present dollars:
Dollars needed to buy the same:
J
$1,861,054
1
$806
$1,240
5
$341.1
$2,932
10
15
20
25
30
35
$116.35
$39.69 $13.54
$4.62
$1.58
$0.54
$8,594 $25,196 $73,864 $216,542 $634,820 $1,861,054
The I'm so good act
The disappearing money act
$900
$2,000,000
$800
$700
$1,500,000
$600
$500
$1,000,000
$400
$300
$500,000
$200
$100
$0
$0
0
0
10
20
30
40
10
20
30
40
Inflation revisited
It is also illustrative to see what a change in interest rates means
A
2
3
4
5
6
7
8
9
10
11
12
13
14
B
C
D
E
F
G
H
I
J
K
L
Inflation
Present Value
Number of years
1,000.00
25
Inflation
Worth in present dollars:
Dollars needed to buy the same:
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
8.00%
10.00%
$779.77
$609.53
$477.61
$375.12
$295.30
$233.00
$146.02
$92.30
$1,282.43 $1,640.61 $2,093.78 $2,665.84 $3,386.35 $4,291.87 $6,848.48 $10,834.71
The I'm so good act
Amount needed for same goods vs
Inflation
The disappearing money act
Value in 25 years vs Inflation
$1,000.00
$800.00
$600.00
$400.00
$200.00
$0.00
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
$12,000.00
$10,000.00
$8,000.00
$6,000.00
$4,000.00
$2,000.00
$0.00
0.00%
2.00%
4.00%
6.00%
8.00% 10.00% 12.00%
Asset Classes & Inflation
So whatever we do, we need to take inflation into account
when comparing the performance of asset classes.
Actually, there is no reason to be
sad. As such, moderate inflation is
not necessarily a bad thing as long
as your income growth and/or
return on investment can outpace it
sufficiently.
Asset Classes & Risk
As mentioned in the lecture on values, risk is an essential
issue when evaluating the merits of an investment.
Asset Class
Money Market
Bonds
Stocks
Risk
Extremely low
Very low
Medium to High
Hopefully, this will be reflected in the historical returns.
Historical Data
Let us have a look at Siegel’s data again.
Stocks
Bonds
Gold
Dollar
Historical Data - CPI
The consumer price index (CPI) is a good proxy for inflation
and therefore a closely watched number. A lot of information
(for the US) can be found at the website of the bureau of
labour: http://stats.bls.gov/cpi/home.htm
A good page for some useful statistics is:
http://146.142.4.24/cgi-bin/surveymost?cu .
Lets get the average data for most of the past century.
Historical Data - CPI
How does one get these data into Excel?
Fortunately, Excel can open html files. But
everything ends up in one column.
Data extracted on: December 11, 2000 (10:34 PM)
Consumer Price Index-All Urban Consumers
Series ID : CUUR0000SA0
Data:
Year
1913
1914
1915
1916
Jan
Feb
Mar Apr May
Jun
Jul
Aug
Sep
Oct
Nov Dec
Ann
9.8
9.8
9.8
9.8
9.7
9.8
9.9
9.9
10.0 10.0 10.1 10.0 9.9
10.0 9.9
9.9
9.8
9.9
9.9
10.0 10.2 10.2 10.1 10.2 10.1 10.0
10.1 10.0 9.9
10.0 10.1 10.1 10.1 10.1 10.1 10.2 10.3 10.3 10.1
10.4 10.4 10.5 10.6 10.7 10.8 10.8 10.9 11.1 11.3 11.5 11.6 10.9
Historical Data - CPI
Use the ‘Text to Columns’ feature in the Data menu, throw
out the monthly data and calculate the percentages.
1954
1955
1956
1957
1958
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
26.9
26.8
27.2
28.1
28.9
29.1
29.6
29.9
30.2
30.6
31
31.5
32.4
33.4
34.8
36.7
38.8
40.5
41.8
44.4
49.3
0.75%
-0.37%
1.49%
3.31%
2.85%
0.69%
1.72%
1.01%
1.00%
1.32%
1.31%
1.61%
2.86%
3.09%
4.19%
5.46%
5.72%
4.38%
3.21%
6.22%
11.04%
=(B3-B2)/B2
That’s better!
Historical Data - CPI
Let us compare:
Compounded with a simple average
Compounded with the correct average inflation Rate
Actual Data
Year
1913
1914
1915
1916
1917
1918
1996
1997
1998
1999
Ann
9.90
10.00
10.10
10.90
12.80
15.10
156.90
160.50
163.00
166.60
Change
Average
1.01%
1.00%
7.92%
17.43%
17.97%
2.95%
2.29%
1.56%
2.21%
10.24
10.60
10.97
11.35
11.74
167.50
173.30
179.31
185.53
Rate
10.23 Average:
10.57 Rate:
10.92
11.29
11.67
150.98
156.01
161.22
166.60
=AVERAGE(C3:C88)
3.47%
3.34%
=POWER((B88/B2),1/(A88-A2))-1
=FV($G$4,A88-$A$2,0,-$B$2)
A big difference!
=FV($G$3,A88-$A$2,0,-$B$2)
Historical Data - CPI
What is historical? Which period should one look at?
Year Actual CPI
1913
9.90
1914
10.00
1915
10.10
1916
10.90
1917
12.80
1918
15.10
1919
17.30
1920
20.00
1921
17.90
1922
16.80
1923
17.10
1924
17.10
1925
17.50
1926
17.70
1927
17.40
1928
17.10
1929
17.10
1930
16.70
1931
15.20
1932
13.70
1933
13.00
1934
13.40
1935
13.70
Change
Rate
1.01%
1.00%
7.92%
17.43%
17.97%
14.57%
15.61%
-10.50%
-6.15%
1.79%
0.00%
2.34%
1.14%
-1.69%
-1.72%
0.00%
-2.34%
-8.98%
-9.87%
-5.11%
3.08%
2.24%
10.23
10.57
10.92
11.29
11.67
12.06
12.46
12.87
13.30
13.75
14.21
14.68
15.17
15.68
16.20
16.74
17.30
17.88
18.47
19.09
19.72
20.38
CPI, when compounding with the correct
average inflation rate
Rate:
Actual CPI
Compounded
3.34%
Average Inflation?
180.00
160.00
140.00
120.00
100.00
80.00
60.00
40.00
20.00
0.00
1900
High Inflation?
1920
1940
1960
Low Inflation?
1980
2000
2020
Historical Data – Dow Jones
The Dow Jones is a good reference for the overall
performance of the stock market.
Dow Jones has a nice website with many data:
http://averages.dowjones.com/home.html
As does Standard and Poor’s:
http://www.spglobal.com/index.html
Historical Data – Dow Jones
The difference between the two periods is very big.
Pd. Ending
Close
%change
31/12/1999
11,497 25.22%
31/12/1998
9,181 16.10%
31/12/1997
7,908 22.64%
31/12/1996
6,448 26.01%
31/12/1995
5,117 33.45%
31/12/1994
3,834
2.14%
31/12/1993
3,754 13.72%
31/12/1992
3,301
4.17%
31/12/1991
3,169 20.32%
31/12/1990
2,634
-4.34%
31/12/1989
2,753 26.96%
31/12/1988
2,169 11.85%
31/12/1987
1,939
2.26%
31/12/1986
1,896 22.58%
31/12/1985
1,547 27.66%
31/12/1984
1,212
-3.74%
31/12/1983
1,259 20.27%
31/12/1982
1,047 19.60%
31/12/1981
875
-9.23%
31/12/1980
964 14.93%
Simple Average
Compounding Rate
8.10%
5.76%
Since 1913
Simple Avergage
Compounding Rate
8.86%
10.86%
Since 1965
Repeat: Do not blindly trust averages.
These calculations do not take dividends into account.
Historical Data – Dow Jones
Let us see what happens if we take dividend into account
Pd. Ending
Close
%change w/Dividend
31/12/1999 11,497.12
25.22% 83,132.67
31/12/1998 9,181.43
16.10% 65,345.60
31/12/1997 7,908.25
22.64% 55,330.74
31/12/1996 6,448.27
26.01% 44,392.44
31/12/1995 5,117.12
33.45% 34,678.88
31/12/1994 3,834.44
2.14% 25,602.72
31/12/1993 3,754.09
13.72% 24,584.90
31/12/1992 3,301.11
4.17% 21,245.16
31/12/1991 3,168.83
20.32% 20,010.52
31/12/1990 2,633.66
-4.34% 16,359.15
31/12/1989 2,753.20
26.96% 16,751.13
31/12/1988 2,168.57
11.85% 12,989.40
31/12/1987 1,938.83
2.26% 11,409.22
31/12/1986 1,895.95
22.58% 10,943.05
31/12/1985 1,546.67
27.66%
8,783.95
31/12/1984 1,211.57
-3.74%
6,774.60
31/12/1983 1,258.64
20.27%
6,894.57
31/12/1982 1,046.54
19.60%
5,638.81
31/12/1981
875.00
-9.23%
4,637.18
31/12/1980
963.99
14.93%
4,998.57
Simple Average
Compounding Rate
8.11%
8.01%
Since 1913
=D7*(1+C6+$G$16)
Simple Average
Compounding Rate
8.86%
13.78%
Assumed Dividend
2.00%
Since 1965
Dividend has a significant impact. And of course we should
not use the average but the yearly values for the dividend.
Historical Data - Bonds
Quite a lot of information on bonds can be found at:
http://www.federalreserve.gov/rnd.htm
Historical Data – Bonds
Yield on the 10 year treasury note
Year
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
Yield
3.95
4.00
4.19
4.28
4.93
5.07
5.64
6.67
7.35
6.16
6.21
6.85
7.56
7.99
7.61
7.42
8.41
9.43
11.43
1.04
1.08
1.13
1.17
1.23
1.29
1.37
1.46
1.57
1.66
1.77
1.89
2.03
2.19
2.36
2.53
2.75
3.01
3.35
1961
1
Simple Average
Compounded Rate
7.53%
7.51%
16.00
14.00
12.00
10.00
8.00
6.00
4.00
2.00
0.00
1960
1970
1980
1990
2000
2010
Historical Data – Comparing
It is illustrative to compare the relative changes:
Year
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
Bond Yield
3.95%
4.00%
4.19%
4.28%
4.93%
5.07%
5.64%
6.67%
7.35%
6.16%
6.21%
6.85%
7.56%
7.99%
7.61%
7.42%
8.41%
9.43%
11.43%
13.92%
CPI Change
1.00%
1.32%
1.31%
1.61%
2.86%
3.09%
4.19%
5.46%
5.72%
4.38%
3.21%
6.22%
11.04%
9.13%
5.76%
6.50%
7.59%
11.35%
13.50%
10.32%
DJ Change
-10.81%
17.00%
14.57%
10.88%
-18.94%
15.20%
4.27%
-15.19%
4.82%
6.11%
14.58%
-16.58%
-27.57%
38.32%
17.86%
-17.27%
-3.15%
4.19%
14.93%
-9.23%
Bond Yield
CPI Change
DJ Change
50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
1960
-10.00%
-20.00%
-30.00%
-40.00%
1970
1980
1990
2000
2010
Historical Data – Comparing
.. And the what that means for 1000 dollars:
Year
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
Bonds
1039.50
1081.08
1126.38
1174.59
1232.49
1294.98
1368.02
1459.26
1566.52
1663.02
1766.29
1887.28
2029.96
2192.15
2358.98
2534.01
2747.12
3006.18
3349.78
3816.07
4312.55
4791.24
5388.23
CPI Stocks no/D Stocks w/ D
1010.00
891.90
911.90
1023.33
1043.52
1085.16
1036.74
1195.56
1264.97
1053.43
1325.64
1427.90
1083.56
1074.57
1186.01
1117.04
1237.90
1390.01
1163.84
1290.76
1477.16
1227.39
1094.69
1282.32
1297.60
1147.46
1369.78
1354.43
1217.56
1480.87
1397.91
1395.09
1726.40
1484.86
1163.78
1474.69
1648.79
842.93
1097.61
1799.32
1165.94
1540.17
1902.96
1374.17
1846.04
2026.65
1136.85
1564.15
2180.48
1101.04
1546.16
2427.96
1147.18
1641.87
2755.73
1318.45
1919.84
3040.13
1196.76
1781.04
3227.40
1431.32
2165.74
3331.00
1721.45
2648.05
3474.90
1657.07
2601.98
1000 Starting sum
Divid Assumed average annual dividend on DJ stocks
2%
35000.00
30000.00
25000.00
20000.00
15000.00
10000.00
5000.00
0.00
1960
Bonds
Are stocks really better than bonds?
1970
1980
CPI
1990
Stocks no/D
2000
Stocks w / D
2010
Comparison
Once again, the conclusion one can draw from these
data depends entirely on one’s perspective. The
numbers alone mean little.
The interpretation of the numbers must be
justified by sound arguments.
Understanding is the ONLY way even if it
means going through some math! Solely
memorizing convenient Excel functions is
pointless!
Key Points of the Day
The comparison of data is essential in understanding
business data.
Know what the numbers mean. The average, e.g., may not
be what you think.
The three main asset classes
have rather different historical
performances.