Does past performance really = future returns?

[KlangFool]

Allow me to ask an un-knowable question:

If people freak out during a correction of the USA stock market, do they typically just go to cash or do they try and find another home for their investments (e.g. bonds, or international stocks)?

MikeT,

With or without unemployment?

If someone is unemployed, they are forced to sell stock to feed their family when they run out of their emergency fund. This has nothing to do with whether they are freak out. This recurred in every recession.

KlangFool

[watchnerd]

However, taking a step back, allow me to question the central assumption: does the past really predict the future?

No.

It's dangerous to assume stock returns will be the same as the past.

The only thing one can say is that stocks should outperform bonds over the long haul, most of the time, in order to compensate for the extra risk.

However, that outperformance may be small and doesn't always happens. Sometimes stocks lose to bonds, as they must from time to time, else they wouldn't be riskier.

So if you want to guess the future:

Look at current 10 year bond yields.

Hypothetically, stocks should do better than that over a 10 year period (but not guaranteed and maybe not by much).

[watchnerd]

Since no on one knows during the next 30 years if stocks will do better or bonds will do better, why isn't it the consensus view to split the baby and go 50/50 ?

Likewise, 50/50 USA vs non-usa stocks?

-Mike

Because stocks should do better over the long haul as compensation for the extra risk.

It's not a simple coin flip.

So if you want higher returns, you add more stocks on the hope that the risk is compensated with higher returns.

(it might not be)

[watchnerd]

Regarding ERP, some people will argue that current prices are high for US stock, and bond rates are no too shabby, so the premium is currently low and you should own more bonds. They are still relying in historical analysis to make a determination of "overvalued" and who knows what will happen to bonds.

That's an overly broad statement.

There are lots of valuation models that don't rely on historical analysis.

DCF modeling, for example, doesn't rely on historical data.

[dbr]

I think the fact that investment returns have been variable and unpredictable in the past predicts that investment returns will be variable and unpredictable in the future.

Is that a yes or a no to the question "Does past performance really = future returns?"?

[watchnerd]

I think the fact that investment returns have been variable and unpredictable in the past predicts that investment returns will be variable and unpredictable in the future.

Is that a yes or a no to the question "Does past performance really = future returns?"?

I wouldn't necessarily agree with that.

The future could be dominated by mutli trillion dollar institutional AI trading that decides that the best outcome for future retirement planning is to run everything as a huge low volatility fund.

This would lower volatility and lower returns.

It would be still subject to exogenous shocks, but at least the human 'irrational exuberance' and speculation would be dialed back.

It's the same thing we've seen with interest rates over the centuries coming down as loaning people money has become progressively less riskier.

[MikeT]

This guy just put some charts out that address a bunch of questions that keep coming up over here.

Put These Charts on Your Wall (2024 Edition) | Charlie Bilello | Creative Planning

Thanks to everyone for all these wonderful insights.

I particularly like this video and wanted to stop just 2 minutes into watching it to say how much I love charts like this!



Thanks @anoop

[Northern Flicker]

The dollar is not "the" reserve currency, merely the largest. There is no "the" reserve currency.

According to the International Monetary Fund (IMF), there are currently eight "Official Foreign Exchange Reserves:"

About 60% of foreign exchange reserves worldwide are held in USD, giving it status as the primary reserve currency, and leading to a large share of int'l trade settled in US dollars.

https://www.cfr.org/backgrounder/dollar ... e-currency

The current status quo is why investors outside the US do well to include US stocks in their portfolio. The possibility of the status quo changing is why US investors do well to include ex-US stocks in their portfolio.

[Beensabu]

Since no on one knows during the next 30 years if stocks will do better or bonds will do better, why isn't it the consensus view to split the baby and go 50/50 ?

Likewise, 50/50 USA vs non-usa stocks?

Makes sense to me.

Some refer to it as "naive diversification".

I suppose I'm naive. But diversified.

[anoop]

Since no on one knows during the next 30 years if stocks will do better or bonds will do better, why isn't it the consensus view to split the baby and go 50/50 ?

Likewise, 50/50 USA vs non-usa stocks?

Makes sense to me.

Some refer to it as "naive diversification".

I suppose I'm naive. But diversified.

Look up Dollar Milkshake Theory. It says that by design the system ensures that when there is stress, the USD will go up and capital will flow to the US. I expect to see much more stress in the future and we have seen this is true (dollar spikes every time there any kind of stress in the financial system).

For me, US stock market is plenty diversification. The US is also probably the only country where the entire pension system will cease to function if the stock market doesn't keep going up in perpetuity. Even other countries sovereign funds invest massively in US stocks!

[Northern Flicker]

Other countries and/or their residents investing sizable amounts in US stocks in no way implies that US investors should eschew ex-US stocks. Perhaps you have some valid reasons to avoid ex-US stocks, but that is not one of them.

[Beensabu]

Look up Dollar Milkshake Theory.

Aw. I thought it was going to be a Daniel Day-Lewis reference about the US markets sucking up all the global liquidity...

What a waste of a theory name.

[watchnerd]

Look up Dollar Milkshake Theory.

Aw. I thought it was going to be a Daniel Day-Lewis reference about the US markets sucking up all the global liquidity...

What a waste of a theory name.

I mean...it kind of is, isn't it?

[anoop]

Aw. I thought it was going to be a Daniel Day-Lewis reference about the US markets sucking up all the global liquidity...

What a waste of a theory name.

I mean...it kind of is, isn't it?

The US is the oil man the world’s capital is the oil in ground.

[unwitting_gulag]

For example, if you look at a 15 year old child who has grown from 1 foot tall to 6 feet tall, does he continue growing, to become 12 feet tall?

That's a fascinating philosophical question!

In the case of the child, we have vast medical and demographic data. We can reasonably estimate a range of eventual adult height based on the child's height at age 15. We can be almost sure, for example, that the child won't shrink. This is because we have lots of data, and also physical (physiological) reasoning. That excludes, for example, becoming 12 feet tall. So, whereas it's silly to linearly extrapolate growth between say age 0 and age 5, to that between 5 and 10, 10 and 15 , and 15 and 20, our plethora of data allows us to make reliable statistical statements about the future height of any 15 year old, anywhere in the world.

One problem with stock market predictions, is dearth of data. There are billions of children, but the stock market as we know it, is only around 200 years old, with reliable data only back to the late 1800s, and in many cases, not even that. Meanwhile, we know that markets move in long undulations, not strictly speaking waves of a definable period, but in clusters of some years this, and some years that. I mean the bear market of 1968-1982, bull of 1982-2000, bear of 2000-2009 and so on. These are crude and approximate, but the gist is, that these "waves" have a period of some years, and our data is only 150 years... ergo, we don't have very many data points. Maybe 20 or 30 data points, put that way.

If our data is limited, our predictions will be spotty and rough.

Then there's the matter of physical laws. A 12 foot tall human is impossible. A 50% annual loss in the stock market, is rare, but not impossible. There is no physical law that says that markets "have to" do any particular thing.. respond to inflation, interest rates, politics, hem lines,...

Between dearth of data and lack of physical laws, we're stuck. There is enough data to speak in generalities, such as stocks being long-term more lucrative than bonds. But there is neither an overwhelming data set nor a coherent physical law. In the investment world, that 15 year old child could indeed grow to be a 12' tall adult, or shrink back down to 1'.

[snackdog]

We can only hope the wide range of past performance, domestically and otherwise, brackets the range of forward behavior. Time will tell. We may all wish we put it all under the mattress in ten years.

[cosmos]

We can only hope the wide range of past performance, domestically and otherwise, brackets the range of forward behavior. Time will tell. We may all wish we put it all under the mattress in ten years.

Is there some coming/impending change that would necessitate mattress stuffing?

[Beensabu]

Aw. I thought it was going to be a Daniel Day-Lewis reference about the US markets sucking up all the global liquidity...

What a waste of a theory name.

I mean...it kind of is, isn't it?

I guess... not so far as sucking dry, though.

One thing I found keeps talking about the USD "milkshake" being attractive to global capital and the "sucking" creating a vortex-like pull. Another thing says the "sucking" is tightening monetary policy, which creates a feedback loop.

Not emptying a reservoir out, but creating a force of motion that draws in.

Makes me think more of Charybdis.

So what is Scylla? Wasn't she the lesser evil?

[watchnerd]

I mean...it kind of is, isn't it?

I guess... not so far as sucking dry, though.

One thing I found keeps talking about the USD "milkshake" being attractive to global capital and the "sucking" creating a vortex-like pull. Another thing says the "sucking" is tightening monetary policy, which creates a feedback loop.

Not emptying a reservoir out, but creating a force of motion that draws in.

Makes me think more of Charybdis.

So what is Scylla? Wasn't she the lesser evil?

Don't cross the streams between ice-cream drinks and Greek mythology.

[babystep]

Since no on one knows during the next 30 years if stocks will do better or bonds will do better, why isn't it the consensus view to split the baby and go 50/50 ?

Likewise, 50/50 USA vs non-usa stocks?

-Mike

If there were only two companies in the world. Company-1 worth 100T dollars and the company-2 worth 1T dollars. We don't know which company would do better in future. Would you split and put 50% into each one of them?

[seajay]

Since no on one knows during the next 30 years if stocks will do better or bonds will do better, why isn't it the consensus view to split the baby and go 50/50 ?

Likewise, 50/50 USA vs non-usa stocks?

-Mike

If there were only two companies in the world. Company-1 worth 100T dollars and the company-2 worth 1T dollars. We don't know which company would do better in future. Would you split and put 50% into each one of them?

100% in either alone and one or the other will be the worst performing share price (total return) wise for the investor. 50/50 of each and that's guaranteed not to be the worst outcome (excepting if both are precisely matched in outcome), but could be the best outcome. For many investment focus is upon reducing risk rather than striving to maximize rewards (but with higher risk).

Rebalance bonus includes a independent [x y] factor, weightings to each of two assets, that is maximized at 0.5 (50%). 0.5 x 0.5 = 0.25. If instead one is weighted 99% the other 1% 0.99 x 0.01 = 0.1 ... you've pretty much thrown away near all of that element benefit. Equal $$$ weighted is inclined to broadly yield the better outcome, with less (worst case) risk.

[watchnerd]

Since no on one knows during the next 30 years if stocks will do better or bonds will do better, why isn't it the consensus view to split the baby and go 50/50 ?

Likewise, 50/50 USA vs non-usa stocks?

-Mike

If there were only two companies in the world. Company-1 worth 100T dollars and the company-2 worth 1T dollars. We don't know which company would do better in future. Would you split and put 50% into each one of them?

Allocate by market weight, as an index would.

[babystep]

If there were only two companies in the world. Company-1 worth 100T dollars and the company-2 worth 1T dollars. We don't know which company would do better in future. Would you split and put 50% into each one of them?

100% in either alone and one or the other will be the worst performing share price (total return) wise for the investor. 50/50 of each and that's guaranteed not to be the worst outcome (excepting if both are precisely matched in outcome), but could be the best outcome. For many investment focus is upon reducing risk rather than striving to maximize rewards (but with higher risk).

Rebalance bonus includes a independent [x y] factor, weightings to each of two assets, that is maximized at 0.5 (50%). 0.5 x 0.5 = 0.25. If instead one is weighted 99% the other 1% 0.99 x 0.01 = 0.1 ... you've pretty much thrown away near all of that element benefit. Equal $$$ weighted is inclined to broadly yield the better outcome, with less (worst case) risk.

We don't know doesn't mean that they both have equal probabilities. Consider investor-1 as someone invested 50:50 and investor-2 is rest of the world collectively invested in these two companies.

Why do you think that investor-2 is invested in 100:1 ratio but investor-1 is invested in 50:50 ratio?

If it was so obvious that they have equal odds then rest of the world that includes professional investors, wouldn't be invested in 100:1 ratio in the first place.

[Beensabu]

I guess... not so far as sucking dry, though.

One thing I found keeps talking about the USD "milkshake" being attractive to global capital and the "sucking" creating a vortex-like pull. Another thing says the "sucking" is tightening monetary policy, which creates a feedback loop.

Not emptying a reservoir out, but creating a force of motion that draws in.

Makes me think more of Charybdis.

So what is Scylla? Wasn't she the lesser evil?

Don't cross the streams between ice-cream drinks and Greek mythology.

Whirlpool identification is important.

A quote from Keynes:

Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.

[dogagility]

For example, if you look at a 15 year old child who has grown from 1 foot tall to 6 feet tall, does he continue growing, to become 12 feet tall?

Finance does not equal biology, so this example is absurd.

If you show me a child's family history, I can make a pretty good prediction of their future height.

[alluringreality]

Since no on one knows during the next 30 years if stocks will do better or bonds will do better, why isn't it the consensus view to split the baby and go 50/50 ?

Likewise, 50/50 USA vs non-usa stocks?

-Mike

Gerd Gigerenzer defended equal weight as a potentially valid strategy for uncertainty. Jack Bogle and Harry Markowitz discussed personal regret minimization in their decisions to split 50/50 between stocks and bonds at times, and they both also discussed alternate approaches. One point of general difference in opinion is if longer timeframes might be viewed as more appropriate for holding stocks. My personal take is that stocks generally exhibit near-term price risk, there are few guarantees when investing in stocks, and due to uncertainty stock investing largely seems a matter of opinion or wealth or liability protection (Ex. 401k). I tend to think of investment timeframe and other items as potentially reasonable stock considerations, yet I can also understand alternate preferences.
https://www.morningstar.com/columns/rek ... sification

There is a fairly recent paper that suggests the latter position. To me it seems mostly based on a longer timeline, and the given criteria essentially makes behavioral issues impossible. Personally I find it difficult to take very seriously, beyond one viewpoint largely based around idealized history, but it's received a fair amount of forum discussion.
viewtopic.php?p=7690511#p7690511

[carolinaman]

Having spent the last two days reading through the wiki's here, I understand that based on the past, a stock heavy portfolio is the most likely to grow and out pace inflation in the long run.

However, taking a step back, allow me to question the central assumption: does the past really predict the future?

For example, if you look at a 15 year old child who has grown from 1 foot tall to 6 feet tall, does he continue growing, to become 12 feet tall?

Even if Moore's Law (the doubling of transistor density doubled every 2 years) was true for a long time, does that mean it will continue to be true forever?

I'm intentionally keeping this general, not about me or my circumstances.

Thoughts please,

-Mike

I agree that past performance is not a sure predictor for the future, but it is likely the best predictor. There are factors that can influence that decision like manager change, huge runup in assets, heavy asset allocation in unfavorable sectors, etc.

Using a baseball analogy, a GM needs a new outfielder. He can trade for a guy who has hit .300+ the past 5 years and averaged 30 home runs a year. Or he can pick a guy who has hit .250 the past 5 years without power. They each have comparable defensive ability. The .300 guy is expensive but affordable. He can get the .250 hitter a lot cheaper. Which would you pick?

[dbr]

I agree that past performance is not a sure predictor for the future, but it is likely the best predictor.

That is a good point. If one wants to dismiss past history as useful information for future expectations the problem then becomes what information is to be used that is better. It can be easy to think we know things that will make a better guess, but we can also be introducing large errors.

[seajay]

I agree that past performance is not a sure predictor for the future, but it is likely the best predictor.

That is a good point. If one wants to dismiss past history as useful information for future expectations the problem then becomes what information is to be used that is better. It can be easy to think we know things that will make a better guess, but we can also be introducing large errors.

History provides a indicator of limits. How far can a flea jump? Sample 100 and you'll have a indicator of lower/upper limits - that is better than a wild guess (absence of any measures). Stock history contains some pretty wild extremes of circumstances (wars, rebounds after deep declines, very high inflation, very low inflation ... etc.) so provided forward time is generally within the bounds of similar circumstances then so also might stocks limits reflect that.

[Investment101]

The dollar is not "the" reserve currency, merely the largest. There is no "the" reserve currency.

According to the International Monetary Fund (IMF), there are currently eight "Official Foreign Exchange Reserves:"

About 60% of foreign exchange reserves worldwide are held in USD, giving it status as the primary reserve currency, and leading to a large share of int'l trade settled in US dollars.

https://www.cfr.org/backgrounder/dollar ... e-currency

For USD to lose its reserve currency status, or for another currency to replace it, I read that it usually takes 2,3,4 decades. However is it still the case due to recent events.

I hold a lot of cash (USD) , so kind of concerned since some say it might crash because of recent events! What do you guys think?

[watchnerd]

That is a good point. If one wants to dismiss past history as useful information for future expectations the problem then becomes what information is to be used that is better. It can be easy to think we know things that will make a better guess, but we can also be introducing large errors.

History provides a indicator of limits. How far can a flea jump? Sample 100 and you'll have a indicator of lower/upper limits - that is better than a wild guess (absence of any measures). Stock history contains some pretty wild extremes of circumstances (wars, rebounds after deep declines, very high inflation, very low inflation ... etc.) so provided forward time is generally within the bounds of similar circumstances then so also might stocks limits reflect that.

Fleas are governed by physics.

Finance is not.

[Beensabu]

For USD to lose its reserve currency status, or for another currency to replace it, I read that it usually takes 2,3,4 decades. However is it still the case due to recent events.

Still the case. Not possible to go from the largest and most liquid bond market to not overnight. Even if there were some coordinated effort at sanctions, who are they going to sell to if everyone has agreed to sell? They'd have to first stop buying, and then sell incrementally to whoever was still willing buy. Which might just be the Fed. So if the Fed doesn't buy, then how do they get rid of it without taking a huge loss? All they can do is stop buying and wait it out until something else becomes at least as large and liquid, and that takes a lot of time.

[Thesaints]

Having spent the last two days reading through the wiki's here, I understand that based on the past, a stock heavy portfolio is the most likely to grow and out pace inflation in the long run.

The part in bold is the key. It would be very naive to base the expectation on past results. On the other hand, if one understands how stocks, bonds, and inflation work, the expectation can be based on the far more solid "mechanics of the economy".

[KanCityKid]

We can only hope the wide range of past performance, domestically and otherwise, brackets the range of forward behavior. Time will tell. We may all wish we put it all under the mattress in ten years.

Is there some coming/impending change that would necessitate mattress stuffing?

Yes, there is - stagflation. During the last stagflation event (1968 - 1981), stocks, bonds and bills all had negative real returns.

[seajay]

Is there some coming/impending change that would necessitate mattress stuffing?

Yes, there is - stagflation. During the last stagflation event (1968 - 1981), stocks, bonds and bills all had negative real returns.

The prior ten years to that 1968 start date saw stocks gain +11% annualized real. The ten years following that 1981 end year saw stocks gain +13% annualized real. The 1968-1981 years saw -1.6% annualized real, so averaged with either prior or post 10 years and that aligned more with the longer term average.

The last 10 years to end of 2024 has seen stocks yield 10% annualized real (above average) such that the forward 10 years COULD be low (or even negative).

Thirds midcap stocks, silver, intermediate treasury's smoothed down that multi-year volatility, yielded a more consistent average, where that lower volatility also reflects through to the likes of 30 year SWR outcomes



but even that isn't immune to volatility, in the case of the 1936/1937 start years .... 1933/4/5 saw the portfolio value gain 23% annualized real. In 1979 alone it gained 125% i.e. starting a 30 year SWR run after recent strong gains and you might have reduced your SWR expectations in reflection of those recent high/large gains.

[gunny]

Since no on one knows during the next 30 years if stocks will do better or bonds will do better, why isn't it the consensus view to split the baby and go 50/50 ?

Likewise, 50/50 USA vs non-usa stocks?

Because the odds are waaaaaaaaay in stocks' favor over bonds. How is that not obvious?

[gunny]

I agree that past performance is not a sure predictor for the future, but it is likely the best predictor. There are factors that can influence that decision like manager change, huge runup in assets, heavy asset allocation in unfavorable sectors, etc.

Someone gets it, thank you. I'm so sick of hearing "part performance is no guarantee..." well duh. That doesn't mean it isn't an important consideration.

[Beensabu]

I'm so sick of hearing "part performance is no guarantee..." well duh. That doesn't mean it isn't an important consideration.

It's an important consideration if you look at past performance in terms of past behavior of asset classes throughout various market conditions, and not for returns.

[watchnerd]

Since no on one knows during the next 30 years if stocks will do better or bonds will do better, why isn't it the consensus view to split the baby and go 50/50 ?

Likewise, 50/50 USA vs non-usa stocks?

Because the odds are waaaaaaaaay in stocks' favor over bonds. How is that not obvious?

Because sometimes it doesn't happen that stocks beat bonds.

And the consequences of overweighting the riskier bet could be damaging to retirement income security if stocks lose badly.

If allocating more to stocks was obviously always the winning strategy, we would see that as the default recommendation for retirement portfolios (as opposed to accumulation). But we don't because it isn't always the winning strategy.

[secondopinion]

I'm so sick of hearing "part performance is no guarantee..." well duh. That doesn't mean it isn't an important consideration.

It's an important consideration if you look at past performance in terms of past behavior of asset classes throughout various market conditions, and not for returns.

Agreed. I rather make a portfolio that does reasonably in most cases rather than well for only a few cases.

[dbr]

I'm so sick of hearing "part performance is no guarantee..." well duh. That doesn't mean it isn't an important consideration.

It's an important consideration if you look at past performance in terms of past behavior of asset classes throughout various market conditions, and not for returns.

Right. This is the most completely misunderstood "urgent warning not to do" around. The antidote is a dose of critical thinking skills.

[gunny]

It's an important consideration if you look at past performance in terms of past behavior of asset classes throughout various market conditions, and not for returns.

Right. This is the most completely misunderstood "urgent warning not to do" around. The antidote is a dose of critical thinking skills.

That merits repeating.

[rkhusky]

If I flip a coin and it comes up heads 10 times in a row, should I bet my whole portfolio that it will come up heads the 11th time?

[watchnerd]

If I flip a coin and it comes up heads 10 times in a row, should I bet my whole portfolio that it will come up heads the 11th time?

Sounds like you should check if you have an unbalanced coin.

If the coin is fair, no you should not take that bet.

If the coin is unbalanced, you should.

[rkhusky]

If I flip a coin and it comes up heads 10 times in a row, should I bet my whole portfolio that it will come up heads the 11th time?

Sounds like you should check if you have an unbalanced coin.

If the coin is fair, no you should not take that bet.

If the coin is unbalanced, you should.

No way to tell except by betting and flipping and computing probabilities. And you have a limited number of flips, the number of which you don’t know.

[BrooklynInvest]

I think the issue is often the type of generalizations we can make based on history.

Based on history, my expectation is that the total return on my stocks should outpace that of my bonds over the next 10 years.

I could be wrong. Also, I don't buy my bonds for gains. I bought them for diversification, stability and income.

Where this goes wrong in a hurry is that my general and non-binding observation goes from "past performance indicates my stocks should outperform bonds over time" to "past performance indicates that small cap value will outperform the S&P in periods when inflation is rising but not above 5%" or whatever nonsense the Kudlows, Cramers and Cathy Woods of the world are blabbering about currently.

A logical question then is where to draw the line. Me, I draw it at 70-30 and then go get a beer.

[watchnerd]

Sounds like you should check if you have an unbalanced coin.

If the coin is fair, no you should not take that bet.

If the coin is unbalanced, you should.

No way to tell except by betting and flipping and computing probabilities. And you have a limited number of flips, the number of which you don’t know.

The odds of getting heads 10 times in a row is 1 in 1024.

I'm going to therefore say that the coin is likely to be unbalanced.

In which case, I will bet that the coin will come up heads again on the 11th flip.

[rkhusky]

No way to tell except by betting and flipping and computing probabilities. And you have a limited number of flips, the number of which you don’t know.

The odds of getting heads 10 times in a row is 1 in 1024.

I'm going to therefore say that the coin is likely to be unbalanced.

In which case, I will bet that the coin will come up heads again on the 11th flip.

A reasonable choice. I wouldn’t bet much though, since 1/1000 isn’t a sure thing.

[watchnerd]

The odds of getting heads 10 times in a row is 1 in 1024.

I'm going to therefore say that the coin is likely to be unbalanced.

In which case, I will bet that the coin will come up heads again on the 11th flip.

A reasonable choice. I wouldn’t bet much though, since 1/1000 isn’t a sure thing.

What's the payout?

[rkhusky]

A reasonable choice. I wouldn’t bet much though, since 1/1000 isn’t a sure thing.

What's the payout?

I don’t want to go down a rabbit hole with the analogy. Suffice it to say that past performance does not guarantee future results, even for situations where you appear to know the stationary probabilities.