Wednesday, May 8, 2013

Is a 15% Return High or Low?

Stingy Investor pointed to a set of slides from Fairfax Financial Holdings that began with the quote “We expect to compound our book value per share over the long term by 15% annually.” Averaging a 15% per year return on a stock sounds great right now, but not too long ago it would have seemed very low.

Back in the late 1990s as tech stocks boomed, expectation for stock returns were well above 15% per year. These expectations turned out to be hopelessly unrealistic, but back then many investors wouldn’t have given Fairfax a second look if the company was only shooting for 15% per year.

I find this a useful reminder of how the world and people’s expectations can change drastically. It’s hard to even imagine a world with double-digit interest rates, but they could easily come back again. It’s dangerous to make your plans expecting today’s conditions to persist indefinitely into the future.

Every time I’m tempted to mortgage my house for half a million dollars and invest the proceeds, I think back to my brother- and sister-in-law who at one time had a mortgage at over 20%. That stops me pretty quickly. I don’t really have any appetite for debt.

6 comments:

  1. My understanding is that we should expect 6%-7% on equities over the long term. So when interest rates are 1%, for my personal purposes I still assume 6%. And when interest rates are 15%, I still assume 6%.

    However I think the much more important number is the difference between inflation and interest earnings. If inflation is at 12% and you're earning 11%, then you're actually going backwards. If inflation is running at 3% and you're earning 8%, then I need to know your secret :).

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    1. @Glenn: I prefer to think in terms of real returns (above inflation) as you mention. I'm hoping for 3-4% real returns from stocks over the long term, but I'm not planning to retire until I'd be safe with 0% real returns.

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  2. I would be more than happy to get 4% real returns until forever.

    I figure a healthy a dividend and ETF portfolio into the 7-figures, a paid off home and some pension money should do the trick.

    15% returns would definitely accelerate the plan though Michael :)

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  3. You know it's not the topic of the post, but I have to point out that anytime anyone talks about the bad old days of mortgages at 20% they never mention that also back then you could afford a home on one income. I'd gladly trade my 3% mortgage for 20% if I could have paid $80,000 for my house instead of $500,000.

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    1. @Anonymous: That's a good point. An $80,000 mortgage at 20% isn't too bad. A $500,000 mortgage at 3% is worse. But still owing $400,000 on your mortgage 5 years later when rates have risen to 9% is a disaster. (This is not a prediction; it is just one possible future.)

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  4. 15% is an excellent return. Money will double every five years at 15% so that means one thousand dollars would be worth one million dollars in fifty years.

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