# The Profit and Loss Statement (PowerPoint) by leader6

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```									  Asset Classes & Financial Markets

Lecture 11
This lecture is part of Chapter 5:
Becoming a Millionaire
Today’s Lecture
Asset classes
Historical performance
Be critical of numbers,
know what they mean.

Be aware! The data used in this lecture have not been verified
nor are they complete.
They are used for illustrative purposes only!
Asset Classes
While we have already talked about these, it is important to
realize the qualitative difference between them.
The major asset classes are:
• Cash and Money Markets
• Bonds
• Real Estate
• Stocks
There are of course other asset classes … some better
than others
• Cards (Pokemon, Baseball)
• Collections (Coins, Stamps)
• Art (Paintings, Sculptures)
Asset Classes

Asset classes like cards and collections may be excellent but
we shall focus here on the ‘financial’ asset classes of stocks,
bonds and money markets plus real estate.

The main reasons being that theses classes are by far the
largest and most liquid and therefore suitable for all
investors.

Whether or not an asset class is major, its performance will
always be benchmarked. Perhaps the most important
reference benchmark is inflation.
Asset Classes & Inflation

We already had a look at inflation in the lecture on the time
value of money.

If we have a 1000 dollars today, we can ask two (equivalent)
questions:

• How many dollars do we need in 25 years to buy the
same goods that we can buy now for the 1000 dollars?
• What are the 1000 dollars worth in 25 years if we keep
them stored in our mattress?
Inflation revisited
A         B          C            D          E             F          G     H    I
2
3        Inflation
4
5        Present Value               1,000.00
6        Inflation                     4.80%                In this many years   25
7
8
9        Dollars needed to buy the same:        \$3,228.73
10                                                                  =FV(D6,H6,0,-D5)
11       Worth in present dollars:               \$309.72
12
13
14
15
=PV(D6,H6,0,-D5)

That’s a big amount! In order to get a bit a better idea about
the effect of inflation, it is useful to plot a graph.
Inflation revisited
A           B         C           D         E         F         G            H        I        J        K         L
2
3       Inflation
4
5       Present Value             1,000.00
6       Inflation                   4.80%
7
8       Numbers of Years                            1         5        10           15       20       25       30        35
9       Worth in present dollars:           \$954.20   \$791.03   \$625.73       \$494.97  \$391.54  \$309.72  \$245.00  \$193.80
10      Dollars needed to buy the same:    \$1,048.00 \$1,264.17 \$1,598.13 \$2,020.32 \$2,554.03 \$3,228.73 \$4,081.68 \$5,159.94
11
12
The disappearing money act                                    The money grows on trees act
13
14 \$1,200.00                                                         \$6,000.00

\$1,000.00                                                     \$5,000.00

\$800.00                                                     \$4,000.00
\$3,000.00
\$600.00
\$2,000.00
\$400.00
\$1,000.00
\$200.00
\$0.00
\$0.00                                                                 0      10         20        30         40
0   5   10   15    20   25    30   35    40
Asset Classes & Inflation

Let’s see what this would mean for a bit a higher rate.

Say 24%, the same rate most credit card companies charge
you for overdue amounts.
Credit cards are a baaaaad idea (if you don’t pay at once)!!!!
Inflation revisited
Credit Cards

A              B
Yes!!!D These are the correctHnumbers!
C          E    F      G         I                                J         K     L
2                                  Your \$1000 will be worth 54 cents!
3             Inflation
4                                                                                                                    \$0.54
5             Present Value            1,000.00
6
7
Inflation                 24.00%                                                      \$1,861,054
8             Numbers of Years                          1         5         10      15      20       25       30         35
9             Worth in present dollars:            \$806     \$341.1    \$116.35  \$39.69 \$13.54     \$4.62    \$1.58      \$0.54
10            Dollars needed to buy the same:     \$1,240    \$2,932     \$8,594 \$25,196 \$73,864 \$216,542 \$634,820 \$1,861,054
11
12                        The disappearing money act                                     The I'm so good act
13
14   \$900
\$800                                                               \$2,000,000
\$700
\$600                                                               \$1,500,000
\$500
\$1,000,000
\$400
\$300
\$500,000
\$200
\$100                                                                      \$0
\$0                                                                          0      10       20        30   40
0              10        20          30         40
Inflation revisited
It is also illustrative to see what a change in interest rates means
A             B              C           D          E              F       G             H              I          J           K              L
2
3           Inflation
4
5           Present Value                 1,000.00
6           Number of years                     25
7
8           Inflation                                     1.00%     2.00%     3.00%     4.00%     5.00%     6.00%     8.00%     10.00%
9           Worth in present dollars:                  \$779.77   \$609.53   \$477.61   \$375.12   \$295.30   \$233.00   \$146.02      \$92.30
10          Dollars needed to buy the same:           \$1,282.43 \$1,640.61 \$2,093.78 \$2,665.84 \$3,386.35 \$4,291.87 \$6,848.48 \$10,834.71
11
12                                                                                                  The I'm so good act
The disappearing money act
13                                                                                            Amount needed for same goods vs
14
Value in 25 years vs Inflation
Inflation
\$1,000.00

\$800.00                                                                    \$12,000.00
\$10,000.00
\$600.00                                                                     \$8,000.00
\$400.00                                                                     \$6,000.00
\$4,000.00
\$200.00                                                                     \$2,000.00
\$0.00
\$0.00
0.00%   2.00%   4.00%   6.00%   8.00% 10.00% 12.00%
0.00%      2.00%       4.00%   6.00%   8.00%   10.00%   12.00%
Asset Classes & Inflation

So whatever we do, we need to take inflation into account
when comparing the performance of asset classes.

Actually, there is no reason to be
sad. As such, moderate inflation is
not necessarily a bad thing as long
as your income growth and/or
return on investment can outpace it
sufficiently.
Asset Classes & Risk

As mentioned in the lecture on values, risk is an essential
issue when evaluating the merits of an investment.

Asset Class               Risk

Money Market           Extremely low
Bonds                 Very low
Stocks              Medium to High

Hopefully, this will be reflected in the historical returns.
Historical Data
Let us have a look at Siegel’s data again.

Stocks

Bonds

Gold
Dollar
Historical Data - CPI

The consumer price index (CPI) is a good proxy for inflation
and therefore a closely watched number. A lot of information
(for the US) can be found at the website of the bureau of
labour: http://stats.bls.gov/cpi/home.htm

A good page for some useful statistics is:

http://146.142.4.24/cgi-bin/surveymost?cu .

Lets get the average data for most of the past century.
Historical Data - CPI
How does one get these data into Excel?
Fortunately, Excel can open html files. But
everything ends up in one column.

Data extracted on: December 11, 2000 (10:34 PM)

Consumer Price Index-All Urban Consumers

Series ID : CUUR0000SA0

Data:

Year    Jan  Feb   Mar Apr May      Jun    Jul    Aug    Sep  Oct  Nov Dec   Ann
1913    9.8  9.8  9.8  9.8  9.7  9.8   9.9     9.9   10.0 10.0 10.1 10.0 9.9
1914    10.0 9.9  9.9  9.8   9.9 9.9    10.0 10.2 10.2 10.1 10.2 10.1 10.0
1915    10.1 10.0 9.9   10.0 10.1 10.1 10.1 10.1 10.1 10.2 10.3 10.3 10.1
1916    10.4 10.4 10.5 10.6 10.7 10.8 10.8 10.9 11.1 11.3 11.5 11.6 10.9
Historical Data - CPI
Use the ‘Text to Columns’ feature in the Data menu, throw
out the monthly data and calculate the percentages.
1954    26.9    0.75%   =(B3-B2)/B2
1955    26.8   -0.37%
1956    27.2    1.49%
1957    28.1    3.31%
1958    28.9    2.85%
1959    29.1    0.69%
1960    29.6    1.72%
1961    29.9    1.01%
1962    30.2    1.00%
1963    30.6    1.32%
1964      31    1.31%
1965    31.5    1.61%
1966    32.4    2.86%
1967    33.4    3.09%
1968    34.8    4.19%
1969    36.7    5.46%
1970    38.8    5.72%
1971    40.5    4.38%
1972
1973
41.8
44.4
3.21%
6.22%             That’s better!
1974    49.3   11.04%
Historical Data - CPI
Let us compare:
Compounded with a simple average
Compounded with the correct average inflation Rate
Actual Data
Year     Ann    Change   Average     Rate
1913     9.90                                                  =AVERAGE(C3:C88)
1914    10.00    1.01%    10.24     10.23 Average:     3.47%
1915    10.10    1.00%    10.60     10.57 Rate:        3.34%
1916    10.90    7.92%    10.97     10.92                      =POWER((B88/B2),1/(A88-A2))-1
1917    12.80   17.43%    11.35     11.29
1918    15.10   17.97%    11.74     11.67
1996   156.90    2.95%   167.50    150.98
1997   160.50    2.29%   173.30    156.01
1998   163.00    1.56%   179.31    161.22
1999   166.60    2.21%   185.53    166.60
=FV(\$G\$4,A88-\$A\$2,0,-\$B\$2)

A big difference!

=FV(\$G\$3,A88-\$A\$2,0,-\$B\$2)
Historical Data - CPI
What is historical? Which period should one look at?
CPI, when compounding with the correct
Year Actual CPI   Change    Rate
1913       9.90                     average inflation rate
1914     10.00      1.01%   10.23
1915     10.10      1.00%   10.57    Rate:   3.34%                                   Actual CPI
1916     10.90      7.92%   10.92
1917     12.80     17.43%   11.29
1918     15.10     17.97%   11.67                                                    Compounded
1919     17.30     14.57%   12.06
1920
1921
20.00
17.90
15.61%
-10.50%
12.46
12.87                                             Average Inflation?
1922     16.80     -6.15%   13.30            180.00
1923     17.10      1.79%   13.75            160.00
1924     17.10      0.00%   14.21
140.00
1925
1926
17.50
17.70
2.34%
1.14%
14.68
15.17
High Inflation?
120.00
100.00
1927     17.40     -1.69%   15.68
80.00
1928     17.10     -1.72%   16.20
60.00
1929     17.10      0.00%   16.74
40.00
1930     16.70     -2.34%   17.30
1931     15.20     -8.98%   17.88             20.00
1932     13.70     -9.87%   18.47              0.00
1933     13.00     -5.11%   19.09                 1900   1920   1940   1960   1980   2000   2020
1934     13.40      3.08%   19.72
1935     13.70      2.24%   20.38              Low Inflation?
Historical Data – Dow Jones

The Dow Jones is a good reference for the overall
performance of the stock market.

Dow Jones has a nice website with many data:

http://averages.dowjones.com/home.html

As does Standard and Poor’s:

http://www.spglobal.com/index.html
Historical Data – Dow Jones
The difference between the two periods is very big.
Pd. Ending   Close    %change
31/12/1999   11,497 25.22%     Simple Average     8.10%
31/12/1998    9,181 16.10%     Compounding Rate   5.76%    Since 1913
31/12/1997    7,908 22.64%
31/12/1996    6,448 26.01%
31/12/1995    5,117 33.45%     Simple Avergage     8.86%
31/12/1994    3,834    2.14%   Compounding Rate   10.86%   Since 1965
31/12/1993    3,754 13.72%
31/12/1992    3,301    4.17%
31/12/1991    3,169 20.32%
31/12/1990
31/12/1989
2,634   -4.34%
2,753 26.96%
Repeat: Do not blindly trust averages.
31/12/1988    2,169 11.85%
31/12/1987    1,939    2.26%
31/12/1986    1,896 22.58%
31/12/1985    1,547 27.66%
31/12/1984    1,212   -3.74%
31/12/1983    1,259 20.27%
31/12/1982    1,047 19.60%
31/12/1981      875   -9.23%
31/12/1980      964 14.93%

These calculations do not take dividends into account.
Historical Data – Dow Jones
Let us see what happens if we take dividend into account
Pd. Ending    Close    %change w/Dividend
31/12/1999 11,497.12   25.22% 83,132.67   Simple Average     8.11%    Since 1913
31/12/1998 9,181.43    16.10% 65,345.60   Compounding Rate   8.01%
31/12/1997 7,908.25    22.64% 55,330.74
31/12/1996 6,448.27    26.01% 44,392.44
31/12/1995 5,117.12    33.45% 34,678.88
31/12/1994 3,834.44     2.14% 25,602.72
31/12/1993 3,754.09    13.72% 24,584.90   =D7*(1+C6+\$G\$16)
31/12/1992 3,301.11     4.17% 21,245.16
31/12/1991 3,168.83    20.32% 20,010.52   Simple Average      8.86%   Since 1965
31/12/1990 2,633.66    -4.34% 16,359.15   Compounding Rate   13.78%
31/12/1989 2,753.20    26.96% 16,751.13
31/12/1988 2,168.57    11.85% 12,989.40
31/12/1987 1,938.83     2.26% 11,409.22
31/12/1986 1,895.95    22.58% 10,943.05
31/12/1985 1,546.67    27.66%  8,783.95   Assumed Dividend   2.00%
31/12/1984 1,211.57    -3.74%  6,774.60
31/12/1983 1,258.64    20.27%  6,894.57
31/12/1982 1,046.54    19.60%  5,638.81
31/12/1981    875.00   -9.23%  4,637.18
31/12/1980    963.99   14.93%  4,998.57

Dividend has a significant impact. And of course we should
not use the average but the yearly values for the dividend.
Historical Data - Bonds

Quite a lot of information on bonds can be found at:

http://www.federalreserve.gov/rnd.htm
Historical Data – Bonds
Yield on the 10 year treasury note

Year   Yield
1962    3.95   1.04           1961          1
1963    4.00   1.08
1964    4.19   1.13      Simple Average           7.53%
1965    4.28   1.17      Compounded Rate          7.51%
1966    4.93   1.23
1967    5.07   1.29
16.00
1968    5.64   1.37
1969    6.67   1.46   14.00
1970    7.35   1.57   12.00
1971    6.16   1.66   10.00
1972    6.21   1.77
8.00
1973    6.85   1.89
1974    7.56   2.03    6.00
1975    7.99   2.19    4.00
1976    7.61   2.36    2.00
1977    7.42   2.53    0.00
1978    8.41   2.75
1960       1970       1980      1990   2000   2010
1979    9.43   3.01
1980   11.43   3.35
Historical Data – Comparing
It is illustrative to compare the relative changes:
Year   Bond Yield   CPI Change   DJ Change
Bond Yield          CPI Change   DJ Change
1962      3.95%          1.00%     -10.81%
1963      4.00%          1.32%      17.00%   50.00%
1964      4.19%          1.31%      14.57%   40.00%
1965      4.28%          1.61%      10.88%   30.00%
1966      4.93%          2.86%     -18.94%
20.00%
1967      5.07%          3.09%      15.20%
10.00%
1968      5.64%          4.19%       4.27%
0.00%
1969      6.67%          5.46%     -15.19%
1960   1970          1980         1990    2000       2010
1970      7.35%          5.72%       4.82%   -10.00%

1971      6.16%          4.38%       6.11%   -20.00%
1972      6.21%          3.21%      14.58%   -30.00%
1973      6.85%          6.22%     -16.58%   -40.00%
1974      7.56%         11.04%     -27.57%
1975      7.99%          9.13%      38.32%
1976      7.61%          5.76%      17.86%
1977      7.42%          6.50%     -17.27%
1978      8.41%          7.59%      -3.15%
1979      9.43%         11.35%       4.19%
1980     11.43%         13.50%      14.93%
1981     13.92%         10.32%      -9.23%
Historical Data – Comparing
.. And the what that means for 1000 dollars:
Year    Bonds        CPI Stocks no/D Stocks w/ D   1000 Starting sum
1962   1039.50   1010.00      891.90      911.90   Divid Assumed average annual dividend on DJ stocks
1963   1081.08   1023.33     1043.52     1085.16    2%
1964   1126.38   1036.74     1195.56     1264.97
1965   1174.59   1053.43     1325.64     1427.90   35000.00
1966   1232.49   1083.56     1074.57     1186.01
1967   1294.98   1117.04     1237.90     1390.01   30000.00
1968   1368.02   1163.84     1290.76     1477.16
25000.00
1969   1459.26   1227.39     1094.69     1282.32
1970   1566.52   1297.60     1147.46     1369.78   20000.00
1971   1663.02   1354.43     1217.56     1480.87
1972   1766.29   1397.91     1395.09     1726.40   15000.00
1973   1887.28   1484.86     1163.78     1474.69
10000.00
1974   2029.96   1648.79      842.93     1097.61
1975   2192.15   1799.32     1165.94     1540.17    5000.00
1976   2358.98   1902.96     1374.17     1846.04
1977   2534.01   2026.65     1136.85     1564.15       0.00
1978   2747.12   2180.48     1101.04     1546.16          1960        1970         1980      1990    2000          2010
1979   3006.18   2427.96     1147.18     1641.87
1980   3349.78   2755.73     1318.45     1919.84              Bonds          CPI     Stocks no/D    Stocks w / D
1981   3816.07   3040.13     1196.76     1781.04
1982   4312.55   3227.40     1431.32     2165.74
1983   4791.24   3331.00     1721.45     2648.05
1984   5388.23   3474.90     1657.07     2601.98

Are stocks really better than bonds?
Comparison

Once again, the conclusion one can draw from these
data depends entirely on one’s perspective. The
numbers alone mean little.

The interpretation of the numbers must be
justified by sound arguments.

Understanding is the ONLY way even if it
means going through some math! Solely
memorizing convenient Excel functions is
pointless!
Key Points of the Day
The comparison of data is essential in understanding