Further explanation about the 10% number. When talking investments, one always uses annualized return which is a geometric mean, not an arithmetic mean. Let me give an example of an arithmetic mean:

(10% + 10% + 10% + 10% + 10%) / 5 = 10%
(0% + 20% + 10% + 5% + 15%) / 5 = 10%

The math is pretty simple for arithmetic mean — add together and then divide by the total count. However, the two do not produce the same geometric mean. The formula for geometric means show the following:

(1.1 * 1.1 * 1.1 * 1.1 * 1.1) ^ (1/5) = 1.1 ==> 10%
(1.0 * 1.2 * 1.1 * 1.05 * 1.15) ^ (1/15) = 1.0977 ==> 9.77%

In either calculation, it does not matter what order the losses and gains happen. So if a mutual fund reports a 2 year annualized gain of 10% and the first year was 0%, the 2nd year was 21% (1.1^2/1.0=1.21) — not 20%. What this means is in a volatile investment with a long-term gain, the gains are far larger than losses.

Because the order does not matter for a long-term investment, the calculations for estimating returns give the same number whether you use 10% a year or 0%+21%+…..+n%.

10% yield…

I’ll try not to make a big deal about it, but most economists believe that the S&P 500 won’t return 10% in the coming years. Their methods differ, but even Bogle expects only highish single digits.

It boils down to this - market fundamentals require that that return of a market should be the % increase in earnings + % discounted future yield. If we go back to the 1920s, that’s 6% + 4%. Current yield is 1.7% and yield earnings aren’t expected to rise.

That’s not to say that the market won’t accept these new return terms via a “goodwill” if it deems US stocks to be less risky. After all, it’s still more than bonds. Or it could mean that there will be a correction to the point where the yield is at the 4% level again.

@lorax

Do you have a link to Bogle stating that he feels S&P500 will not see a 10% average? Over coming years, do you mean 1, 2, 5, 100?

I’m almost done The Bogleheads’ Guide to Investing and I haven’t read anything anywhere that confirms your statement. Of course, this book is written by Bogle fans, but if Bogle subscribes to the same information you’ve posted, I’m wondering why they neglected to mention such a important topic.

Lastly, I can’t picture Bogle predicting the future ….

Hi Trent,

I have been debating about whether or not to include my home’s value in my net worth calculation. If you do not include your home’s value on the “plus” side of the calculation, what do you include on the “minus” side? Is it just the amount due on your mortgage that month? Otherwise, if you’re including the full amount of your mortgage, it somehow seems uneven. For example:

Ex. 1 (including home’s value in net worth calculation [”the old way”]):

Assets
Home value: $300,000

Liabilities
Home mortgage: $210,000

Net worth (assuming all else balances out): $90000

Ex. 2 (not including home’s value, but including full balance of mortgage:

Assets are whatever they are

Liabilities
Home mortgage: $210,000

Net worth (assuming all else balances out): -$210,000 (YIKES!)

Ex.3 (including only what’s due on the mortgage that month):

Assets are whatever they are

Liabilities
Home mortgage (monthly pmt): $1400

Net worth (assuming all else balances out): -$1400

The 3rd example still yields a negative net worth, but it’s nowhere near as frightening as being $210,000 in the hole (even if it’s just on paper). It also feels more realistic than Ex. 1, which, as you imply, is only the perception of being ahead of the game, since it’s unlikely that you’ll be able to sell your house “on a whim.”

Can you (or anyone else) see any flaws in the logic of using the 3rd example to calculate net worth?

thanks!

@eRock

I did a quick google and came up with:
http://www.brill.com/bin/yabb2/YaBB.pl?num=1163384579
but you might find lots more if you troll though the posts on diehards.com.

He wrote this in his books. I think the last one I read was either _Common Sense on Mutual Funds_ or _Bogle on Investing_.

Bogle will be the first to tell you that it’s really impossible to call either the short or intermediate term returns. In one of his books he details his attempt to call the 90s market based on fundamentals. He was very close until the internet bubble.

Unfortunately, forecasting with precision is not something that the market lends itself to. But… very many economists agree that returns will be lower, long term, most using different approaches (PE10, future dividend returns, PE1, etc…).

@eRock

I did a quick google and came up with:
http:// http://www.brill.com/bin/yabb2/YaBB.pl?num=1163384579
but you might find lots more if you troll though the posts on diehards.com.

He wrote this in his books. I think the last one I read was either _Common Sense on Mutual Funds_ or _Bogle on Investing_.

Bogle will be the first to tell you that it’s really impossible to call either the short or intermediate term returns. In one of his books he details his attempt to call the 90s market based on fundamentals. He was very close until the internet bubble.

Unfortunately, forecasting with precision is not something that the market lends itself to. But… very many economists agree that returns will be lower, long term, most using different approaches (PE10, future dividend returns, PE1, etc…).

@eRock

[I tried posting this a couple times, but it seems links aren’t allowed, try googling “bogle market returns 77 site:brill.com” and pick the only link, it has an interview with Bogle]

I did a quick google and came up with an ‘06 interview at
http://www.brill.com
but you might find lots more if you troll though the posts on diehards.com.

He wrote this in his books. I think the last one I read was either _Common Sense on Mutual Funds_ or _Bogle on Investing_.

Bogle will be the first to tell you that it’s really impossible to call either the short or intermediate term returns. In one of his books he details his attempt to call the 90s market based on fundamentals. He was very close until the internet bubble.

Unfortunately, forecasting with precision is not something that the market lends itself to. But… very many economists agree that returns will be lower, long term, most using different approaches (PE10, future dividend returns, PE1, etc…).

Ok, that’s a mess. Hopefully Trent will clean it up!

Bogle does say this — people lose a big portion of their returns to:
(1) expenses
(2) market timing.

So to take advantage of this trend, you can do two things:

(1) overweight in the insurance + mutual fund sector. If people are going to spend 5.75% on front-end loads and 1.5% on expense ratios, let some of that go to your pocket.

(2) Do the opposite of what your parents do. :) If they get the investing mania and start putting money into X, immediately get out and perhaps even short their positions.