chase_logi wrote: ↑
Wed Sep 12, 2018 4:11 pm
It seems that one of the main principle of Bogleheads is "time in the market". This implies that, over the very long course, stock market tends to go up and give us positive real return to our investments. I am curious to hear from the collective knowledge here what is the reasoning behind that belief.
My questions are two-folds:
1. What is the first principle behind the expectation that total stock market (eg, investing in 100% VTI) will give us positive real return over the long term?
2. What are some exceptions in which that is not true over the long run?
Here are my take on those two questions, feel free to correct or add your thoughts into this:
1. Productivity of humankind tend to increase over time. Societies learn and discover new breakthroughs all the time, which translates into higher productivity for everyone. This increase in productivity is reflected in higher productivity of companies, which in turn allows them to become bigger and profitable. Since you are investing in total stock market, your investment essentially grows together as societies become more productive in general.
Remember though that new technology tends to disrupt industry incumbents.
Consider the "Nifty Fifty" superstocks of the early 1970s which included Kodak, Polaroid ... see the problem?
It's observable that the earnings of the stock market don't tend to grow as fast as real GDP (although for the US stock market, in the last 30 years, they have exceeded it, I believe). Thus unless we believe the Price to Earnings Ratio of the stock market can rise towards infinity, eventually stock market has to underperform.
At issue is who gets the benefit of the productivity gains - the worker, or the capital owner? A number of 18-19th century thinkers wrestled with this - David Ricardo and Karl Marx in particular. If you read Thomas Piketty, this is not solved yet.
What is observable is that there are cycles. Maybe robots and Artificial Intelligence give capital extraordinary power over workers. But, maybe, the people who look after us in our old age homes get their bargaining mojo back. It's hard to see a robot doing some of that work and the demographics are pretty much one way for the developed world (and much of the developing world).
2. A few examples on when that rule does not apply, however unlikely they are:
- Imagine a future in which a BigMegaPrivateCompany took over the economy and replaces the function of FAANG companies. However, since it is a private company, it is not reflected in your total stock market investment. As that BigMegaPrivateCompany grow even further, it kills all of the other companies that are part of the TSM. TSM market cap keeps decreasing and you as an investor do not get your return.
- Likewise, a future which are dominated by smaller but private companies could reduce the long term profit of public companies. Note that, in these two examples, the world's productivity is likely still increasing. It is just that we as a common investor might not have an easy way to tap into those growth.
- I guess there is also the possibility that world catasthrophe (eg, nuclear war, pandemic outbreak, etc) could significanly affect global productivity.
Any other thoughts or comments?
There's a book out there that massive accumulations of wealth are followed with periods of extreme violence. Periodically we have wars and revolutions (the period 1914-1920s comes to mind, and the fall of the Russian monarchy and aristocracy, as well as the German, Austro-Hungarian etc.; then the Russian Revolution & Civil War, WW2 in Germany and Central Europe; the Chinese-Japanese war and Chinese Revolution thereafter) to redistribute things, and the cycle begins again.
Setting aside such unpleasant thoughts it's true that private companies appear to grow profits faster than public ones.
It has been the buyback of shares (raising EPS = Profit After Tax/ Number of Shares in Issue) that has driven EPS for quoted US stocks (to a greater extent than in the past). That is related, I am sure, to the prevalence of stock options as a form of executive compensation. I think there's good empirical evidence for that, too.