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Reasonable Expectations kcchongnz
Reasonable expectations
When one invests in the stock market, it is important to have reasonable expectations about returns. The best way to start estimating future stock returns is to look at how well stock markets have done in the past, using the largest data-set available.
The long term total compounded annual return (CAR) from the US equity market of 130 years from 1871 to 2001 is about 13%. After that there was a “lost decade” of zero return. US stock held over a one-year period, the maximum return was 67%. On the other hand, there was also a year with a maximum loss of 39%! However, when the stocks were held in longer duration, say for ten years, the maximum CAR was 17% and the minimum -4%. If the holding period is longer, the CAR was always positive. Stocks held over a 30-year period would have a maximum CAR of 10.6% and a minimum of 2.0%. Investing in Bursa follows roughly the same statistics, albeit with higher volatility. My statistics shows that from 1974 to 2006, KLCI had an average annual return of 12%, not far from the US statistics. I was surprised when I downloaded the longest statistics from Yahoo Finance for KLCI from January 1994 to December 2013, the average annual return and CAR is only about 4.7% and 2.5% respectively. That could be due to the relative high stock prices in January 1994.
Hence with this type of return statistic of the equity market, as a long-term investor, I would have the following mind set in investing:
“I need 10%. I’d be glad to earn 12%. 15% would be great. 20% or more would be terrific. But I won’t try that as that will entail higher risk which I am not willing to bear.”
Yes, there is no free lunch. Risk and return are intertwined with each other; the higher the return expectation, the higher the risk. A nominal return of 10% would provide me with a real return of 6% which is pretty good, assuming an inflation rate of 4%. Moreover the historical risk premium of the equity market has been around 4%, and as the long term risk free rate is about 4%, the 10% expected return would provide me with an excess return, α of 2% a year. That is great as an additional 2% compounded over the years would make a huge difference.
Return expectations must be reasonable. Anything else will get you into trouble, usually through the acceptance of greater risk than is perceived. Expecting too much is likely to lead to disappointment of loss. Trying higher returns usually requires some increase in risk taking; risky stocks, greater portfolio concentration, or increased leverage.
KC Chong in Auckland (17/1/14)
Why reasonable expectations (19/1/14)
I summarize the return from the markets as posted by me earlier on.
- The long term total compounded annual return (CAR) from the US equity market of 130 years from 1871 to 2001 is about 13%.
- After that there was a “lost decade” of zero return.
- US stock held over a one-year period, the maximum return was 67%. On the other hand, there was also a year with a maximum loss of 39%!
- Stocks held over a 30-year period would have a maximum CAR of 10.6% and a minimum of 2.0%.
- From 1974 to 2006, KLCI had an average annual return of 12%.
- From January 1994 to December 2013, the average annual return and CAR of Bursa is only about 4.7% and 2.5% respectively.
So how good is an average investor that he can beat the market, say having a consistent annual return of above 12%? Not unless some combination of the following:
- An extreme depressed market in which to buy (hopefully to be followed by a good environment in which to sell).
- Extraordinary investment skill
- Extensive risk bearing
- Heavy leverage, or
- Good luck
Does an extreme depressed market like that of early 2009 comes along often? In that environment, does he still have the guts to buy big?
Extraordinary investment skill by definition is something very rare. Do you have that over those working for the investment banks and fund houses?
Taking excessive risk in order to earn higher return can also work against you when things don’t turn out well and can get you into deep trouble.
Borrow money to invest or using margins, or leveraging does not improve your return; it merely amplify gains as well as losses. Leverage cuts both ways. Companies borrow money for doing business is well and good and that should be the way; but for individual investors to do for investment in the stock market is definitely not a good practice.
Good luck in investing? I don’t count on that, do you?
Return expectations must be reasonable and that will lead you to a prudent investing practice; not taking big risk in investing in “hot” stocks with no fundamentals, unwilling to pay too much for growth expectations, avoid borrow to invest or with margin financing, etc.
Always remember, if something is too good to be true, it probably is.
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Discussions
3 people like this. Showing 33 of 33 comments
My actual return is less than 10%, pulling down by the big lost in the early stupid years. I do not think my return can climb up to 10% in the foreseeable future,as every1% up requires many K. If I am still surviving, next bull should bring me the 10%.
So, pls do not "Play-Play", it costs you N years to recoup, or maybe you will never be able yo recoup the lost.
2014-01-17 13:55
I did recommend mutual fund too. But I personally do not invest in mutual fund with my free money. I invested significant amount in mutual fund with money from EPF. The return is higher than my own investment in Bursa.
One big reason I do not use own money in mutual fund is because there is no excitement. I enjoy the 爽/刺激感 excitement from Bursa.
2014-01-17 14:04
"I enjoy the 爽/刺激感 excitement from Bursa." I agree. A bull run is better than an orgasm haha.
2014-01-17 14:17
bsngpg,can invest direct in stocks with EPF... I am doing that currently... can go thru JF Apex or Jupiter... but bad thing is they stii charge you the 3 pc upfront fees
2014-01-17 14:26
My 爽is more on the high return on those stocks which I studied a lot and invested for long time. Just like those young time, we spent lot of time in practice and finally won the champion in tournament.
2014-01-17 14:27
Houseofordos: umm! Invest in Bursa with money from EPF? This is a surprise. Will go KWSP's web to check. Thanks.
On KFima, sorry that I at last did not go in together. I used my fund on MKH as I think MKH will benefit from the anticipated uptrend on CPO more than KFima.
2014-01-17 14:35
Who is the super-investor in the world? Most people will think it is Warren Buffet. I also think so.
10 years ago, the compounded annual growth rate of Berkshire Hathaway (BH) was 23% for the longest period. I doubt anybody has beaten his record yet considering the duration of the investment.
Even Buffet admitted that he was lucky, being at the right place (America) and the right time (after the second world war). BH's return for the last 10 years is only at CAR of 7%. Even for the last 5 years when the market recovered from the US sublime crisis until S&P reaching at new high, BH's CAR is only 15.4%.
So do you think my expectations from the equity market reasonable?
Bershire Hathaway 176336 31/12/2013
Period 2-week 6-month 1 year 2-year 3 year 4 year 5 year 10 years
Price 174649 176341 140803 114500 119681 100300 86250 89490
Return of stock 1.0% 0.0% 25.2% 54.0% 47.3% 75.8% 104.4% 97.0%
CAR 28% 0.0% 25.2% 24.1% 13.8% 15.1% 15.4% 7.0%
2014-01-17 15:02
kcchongnz, my opinion is that just as bigger companies find it harder to achieve bigger growth, the same issue here may have happened to BH, obviously during the earlier years when the fund size was smaller, it was easier to maneuver and achieve higher returns. Once the fund becomes too big, it becomes harder to keep growing at the same CAR...
2014-01-17 15:07
Gambling is extremely common human nature. Put in nice word, we call it "risk". When we do calculated risk, it is "investment". If not doing the calculation, it is "speculation".
2014-01-17 16:49
Posted by bsngpg > Jan 17, 2014 02:27 PM | Report Abuse
My 爽is more on the high return on those stocks which I studied a lot and invested for long time. Just like those young time, we spent lot of time in practice and finally won the champion in tournament.
My 爽 is when I write something, many people give good comments; by good comments I don't mean only comments which are agreeable to mine but also from different view points.
My 爽 is also when people wanting to learn fundamental investing from me, though I am not that good either.
2014-01-17 16:55
Between 1974 and 2006 is 32 years, and my investing life is 12 years. Also, in my late 50s, the KLCI's average rise over 32 years is not apt for me. Is an expected average return of 10% every year reasonable, other than in a 1-in-9 or 10-year bust?
2014-01-17 23:47
"Moreover the historical risk premium of the equity market has been around 4%".
kcchongnz, how do you know that the market risk premium is only 4% when the risk free rate is assumed to be 4% also?
2014-01-18 00:49
yungshen1 is u kchongnz.my good friend.
17/01/2014 15:04
hey what about me- am I not your good fren no more? sure or not kcchongnz is your good fren? why u no listen to him :) why u make fun of him (and me ) when your General goreng and you become man of the match?why why why tell me why
2014-01-18 01:04
Posted by cstan > Jan 17, 2014 11:47 PM | Report Abuse
Between 1974 and 2006 is 32 years, and my investing life is 12 years. Also, in my late 50s, the KLCI's average rise over 32 years is not apt for me. Is an expected average return of 10% every year reasonable, other than in a 1-in-9 or 10-year bust?
The market goes in cycle, and that is quite sure. We just don't know exactly which position is the swing of the pendulum now. Within that 32 years, there were already a few cycles.
The historical 10% CAR is a very long term return and that includes the boom and bust. However, the past is a guide and the future outcome may not resemble the past.
So my take is that if your investment horizon is 12 years which is reasonably long, you may use the past as a guide of a reasonable return expectation of about 10%.
2014-01-18 06:39
Nowadays it is not easy to bluff, for sure.
Posted by keanpoh > Jan 18, 2014 12:49 AM | Report Abuse
"Moreover the historical risk premium of the equity market has been around 4%".
kcchongnz, how do you know that the market risk premium is only 4% when the risk free rate is assumed to be 4% also?
Good question. You got me. I was taking a short cut using the US statistic, specifically from Professor Aswath Damodaran. The long term risk premium from 1928-2011 has been 4.10%. The forward looking risk premium in early 2012 was 4.08%. I view this thingy as very approximately and hence I rounded it off at 4% and just adopt it into the Bursa here. There was also this market implied risk premium at 6.01% two years ago. Have fun and read about this at the appended link below:
http://aswathdamodaran.blogspot.co.nz/search?q=equity+risk+premium
Note that these risk premiums happened in a very low risk-free rate environment.
Also note that risk free rate varies across time periods; in the early 1980, it was very high (>10%) and now very low (1%?) in US.
So if I take the risk premium as 4%, and the long-term risk free rate at 4%, the required return of the market is 4%+4%=8%. Hence if I can get a realized return of 10%, or an alpha of 2%, assuming I invest in some selected blue chip companies, I am quite happy about it.
2014-01-18 11:16
Right to the point.
Posted by houseofordos > Jan 17, 2014 03:07 PM | Report Abuse
kcchongnz, my opinion is that just as bigger companies find it harder to achieve bigger growth, the same issue here may have happened to BH, obviously during the earlier years when the fund size was smaller, it was easier to maneuver and achieve higher returns. Once the fund becomes too big, it becomes harder to keep growing at the same CAR...
Berkshire Hathaway though is a big elephant now, it is still able to grow its assets by 25% a year for the last two years.
Yes, when a company, or a fund gets bigger, it is harder to continuously grow at the high rate. To me at the present environment, if a company can grow its earnings by a CAR of 15% a year for the next 10 years, it is already a fantastic feat.
Some people have the idea that a particular company's business is growing so fast that the share price is worth so much so much but they never put down the numbers and see if their expectation is reasonable, like what you did in your reverse discount cash flow analysis.
2014-01-18 12:39
kcchongnz,
I was about to recommend reading Damodaran's writing about Market Risk premium.
There are 3 ways of getting the market risk premium according to this famous valuation professor at the Stern School of Business at NY University:
1. Based on Historical Equity Risk Premium
2. Based on surveys on the expectation of the future
3. Implied risk premium
One can read more about valuation and applied corporate finance from his website: http://pages.stern.nyu.edu/~adamodar/
On the website, he has also included a lot of his findings, data and excel spreadsheets that can be used for valuation. But one should note that these are US stock market data. To use some of these data for Malaysian equity market, one should also consider adding the country risk premium, which can also be found on his website.
2014-01-18 15:08
keanpoh, yes, one can learn a lot about finance in Aswath Damodaran's website. His teaching is also more practical than most the normal finance and investment courses.
I have also adopted some of the valuation spreadsheets from his website for my valuation exercises, very useful indeed. One has to do some modifications though.
Regarding risk premiums, I think it is quite academic as discussed by Aswath, though it is intuitive. Important thing is what do you think is the acceptable return over the bank deposit rate. For me I am happy to have a return of 10% as the long-term bank deposit rate is about 4%, which implies that my risk premium acceptable is 6% over the risk free rate.
2014-01-18 15:50
This post is transported from the "ValueGrowth Investing"
Posted by Chrollo > Jan 17, 2014 06:13 PM | Report Abuse
kcc, which website do you suggest is good that they contains key financial data?? or must we get those data only from annual report??
I don't use from any screener. Hope others can help here.
I use all raw data from financial statements of the company because I emphasize on other metrics than those given by screeners. for example I use ROIC instead of ROE, Enterprise value and Ebit rather than PE ratio. I also require all other primary data for my other analysis.
2014-01-18 16:03
How do day traders survive if the reasonable expectations of returns are only 10 to 20 pct.. surely these guys have to make a lot more than that to actualky make a living from the market..
2014-01-18 20:18
Posted by houseofordos > Jan 18, 2014 08:18 PM | Report Abuse
How do day traders survive if the reasonable expectations of returns are only 10 to 20 pct.. surely these guys have to make a lot more than that to actually make a living from the market..
Are you telling me that most or the majority of the day traders can make a living from the stock market?
2014-01-19 16:28
Why reasonable expectations (19/1/14)
I summarize the return from the markets as posted by me earlier on.
1. The long term total compounded annual return (CAR) from the US equity market of 130 years from 1871 to 2001 is about 13%.
2. After that there was a “lost decade” of zero return.
3. US stock held over a one-year period, the maximum return was 67%. On the other hand, there was also a year with a maximum loss of 39%!
4. Stocks held over a 30-year period would have a maximum CAR of 10.6% and a minimum of 2.0%.
5. From 1974 to 2006, KLCI had an average annual return of 12%.
6. From January 1994 to December 2013, the average annual return and CAR of Bursa is only about 4.7% and 2.5% respectively.
So how good is an average investor that he can beat the market, say having a consistent annual return of above 12%? Not unless some combination of the following:
1. An extreme depressed market in which to buy (hopefully to be followed by a good environment in which to sell).
2. Extraordinary investment skill
3. Extensive risk bearing
4. Heavy leverage, or
5. Good luck
Does an extreme depressed market like that of early 2009 comes along often? In that environment, does he still have the guts to buy big?
Extraordinary investment skill by definition is something very rare. Do you have that over those working for the investment banks and fund houses?
Taking excessive risk in order to earn higher return can also work against you when things don’t turn out well and can get you into deep trouble.
Borrow money to invest or using margins, or leveraging does not improve your return; it merely amplify gains as well as losses. Leverage cuts both ways. Companies borrow money for doing business is well and good and that should be the way; but for individual investors to do for investment in the stock market is definitely not a good practice.
Good luck in investing? I don’t count on that, do you?
Return expectations must be reasonable and that will lead you to a prudent investing practice; not taking big risk in investing in “hot” stocks with no fundamentals, unwilling to pay too much for growth expectations, avoid borrow to invest or with margin financing, etc.
Always remember, if something is too good to be true, it probably is.
2014-01-19 16:34
Mr kcchong, sometimes I wonder whether I shud just channel all my money from klse to unit trust. Some of my unit trust can give me more than 20per cent annual return, of corse not always, but I hv never achieve that kind or high return invest in klse on my own. Sometimes I feel I am just wasting my time and shud just close my eyes and let unit rust fund managers handle my hard earn money.
Any advice? Thx.
2014-01-19 23:30
wwwcomment,
I would be happy if you can name one unit trust giving 12% annual return for year 2014. Where got unit trust giving more than 20% annual return?
Warren Buffet only get 19.8% for his share holders yearly by a long stretch.
I think if we can get 10% return from any good unit trust this year of 2014 we should be really happy and contented.
2014-01-19 23:43
If I am mistaken, I have one closes to 20% per year for the last many years. Another 2-3 close to 15% per year, also for the last many years.
2014-01-20 07:10
wwwcomment: you r not alone. My overall return from unit trust is easily more than double of those from my own investment in Bursa. Sometimes I also wonder If I should just sell all equities in Bursa and give all money to unit trust for higher return and no headache.
I do not do so is because I enjoy the process of investment in Bursa. A quote from WB:"investing is an exercise bringing you an excitement likes catching a fast moving elephant".
2014-01-20 07:24
wwwcomment, you echo my thoughts as well. My goal is to perform better than umit trusts out there.. else waste time doing all this research... furthermore loading costs are not that high nowadays. Can get as low as 2 pct entry fees.
2014-01-20 07:49
Posted by wwwcomment > Jan 19, 2014 11:30 PM | Report Abuse
Mr kcchong, sometimes I wonder whether I shud just channel all my money from klse to unit trust. Some of my unit trust can give me more than 20per cent annual return, of corse not always, but I hv never achieve that kind or high return invest in klse on my own. Sometimes I feel I am just wasting my time and shud just close my eyes and let unit rust fund managers handle my hard earn money.
Any advice? Thx.
I have posted my analysis of some of the unit trust funds in Malaysia before as below. The outcomes have not changed much as it is now. Please refer to their latest performance as the link below:
http://klse.i3investor.com/blogs/invest_made_easy/45026.jsp
So my answer is yes. For those who have no time and not enough knowledge about the market, it may be better to invest in one of the funds which has been consistent in their return. i was quite surprised to find a few of the funds, such as Philip Capital Master growth fund, Kenanga growth fund and MAAKL-HDBS Flexi fund etc. they are quite consistent in their performance too.
Posted by kcchongnz > Aug 6, 2013 10:31 AM | Report Abuse X
This is my personal assessment of Malaysian unit trust funds. To my surprise, they did pretty good as a whole.
Is it a good idea to invest through unit trusts? Which local equity fund is the best?
Once I asked a forumer who has been posting unit trust funds in i3investor what is the average and median CAR of the unit trust funds in Malaysia. He came back and asked me what CAR is. So I have no choice but to go to the Fundsupermart website myself and compiled and tabulate the compounded annual return (CAR) of the equity funds invested in KLSE for the 1, 3 and 5 years.
From the website, there are a total of 68 local equity funds investing in the KLSE. The average 1-year average and median return is both about 15%, 3 years 12.2% and the 5 years 11.6% as shown below:
Table 1: Fund performance in %
Years 1 3 5
Average 15.2 12.1 11.7
Median 14.9 12.3 11.6
Stdev 5.2 3.8 3.5
No.>KLSE 55 51 49
81% 75% 72%
Max 28.5 22.0 20.8
Min 3.6 3.6 4.0
KLSE 10.80 9.90 9.30
How is the past performance of the funds as a whole? My opinion is they did pretty well. The average returns of the unit trusts outperformed KLSE for all holding periods of 1-year, 3-year and 5-year by 4.4%, 2.2% and 2.4% respectively. 81% of the unit trusts outperformed KLSE for 1-year, and 72% for the 5-year. Even if one invested in the worst performer, he still earns more than the fixed deposit, assumed to be about 3.5%. Wonderful! I think I should make some observations as below:
1. The stock market, especially Bursa Malaysia, is far from efficient.
2. The fund managers in Malaysia are better than those from the US as research has shown that US fund managers under-perform the broad market as a whole. But it could also be due to the inefficiency of KLSE that enable them to out-perform.
3. The performance of the good fund manager are pretty consistent too. For example, Philip Capital Master Growth Fund is the No. 1 for the 1-year return of 28.5%. It also did pretty well for the 3-year and 5-year return of 18.4% and 20% respectively. Similar consistency is shown by the top fund for the 3-year, Kenanga Growth Fund at 22%, and MAAKL-HDBS Flexi fund for the 5-year as shown in Table 2 below.
Table 2: Top fund managers, % CAR
Year 1 3 5
1-year PC Master growth fund 28.5 18.4 20.0
3-year Kenanga Growth Fund 22.3 22.0 20.0
5-year MAAKL-HDBS Flexi Fund 20.9 20.5 20.8
My conclusion is that it may be a good idea for ordinary people who have not much knowledge and wish to invest in the equity market to invest in the local unit trust funds.
For individual investor, how is your return compared with the market? How is it compared to unit trusts funds?
Please note this article is just for sharing purpose. I am not a unit trust agent, neither am I a financial advisor.
kcchongnz
2014-01-20 07:52
My actual result in local unit trust can contribute one data point to substantiate the above post by KC.
2014-01-20 09:41
Quite surprise some of you active in i3 forum share the same unit trust view.
I hv been investing in kenanga growth, huang dbs quantum and huang dbs select opportunity, if I am not mistaken, all of them got about 20 percent last year, or even more. Definetely more than what I got from klse.
Market good, I cannot get more than unit trust investing on my own.
Market bad, I usually lost more than unit trust investing on my own also.
I guess I nv no tallent investing myself.
2014-01-20 18:02
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Correct correct correct! However, I also told wannabe active investors that if they consistently perform below market return, they might as well put their money in index tracking mutual fund.
2014-01-17 13:55