Neil Irwin at the New York Times points out that all asset classes around the world are expensive compared to their historical prices. If that’s the case, is there any investment class available that has the potential to provide great returns over the long-term?
Stocks and bonds; emerging markets and advanced economies; urban office towers and Iowa farmland; you name it, and it is trading at prices that are high by historical standards relative to fundamentals. The inverse of that is relatively low returns for investors…
But frustrating as the situation can be for investors hoping for better returns, the bigger question for the global economy is what happens next. How long will this low-return environment last?
The personal finance world operates on the assumption that the last century or so, minus the last decade, is a good reference for stock market expectations going forward. And depending on who you ask, that’s a return of 10 percent, 8 percent, or 6 percent. Regardless of the number, you’d have to go far outside of the mainstream to hear advice for the average investor that is something other than, “Invest mostly in a broad stock market index fund and don’t touch it for the best chance at getting historical returns.”
And this is the same assumption I’m living with. It’s why my investments are mostly in stock market index funds, though I’ve added some bond funds because it made sense to temper the risk of stocks and take advantage of tax advantages. But if my investments don’t end up appreciating over the next several decades, where will I be? Not so much better off than I am today, and if inflation erodes the value of my money (stored in these assets) faster than the values appreciate, then I’ll be worse off.
But what are the alternatives? Not investing my portfolio, keeping my money in cash form, there’s no doubt inflation will erode the value. At least invested, I have a fighting chance.
While the average investor is said to be better off investing in broad index funds, professional investment managers dealing with corporate cash look for undervalued opportunities. Not only are they not finding anything undervalued, but everything is overvalued. A company wants to reinvest in itself by building factories or property, for example, but it won’t if everything is overpriced, and they expect the company won’t get a good return on that investment.
If these professional investors with millions or billions of dollars to invest can’t come up with any good options, how is the average investor supposed to succeed?
Change your expectations.
There’s nothing magical about the 8 percent long-term annual return on the stock market. Most investors don’t see that return, anyway, because their behavior gets in the way. Even if the next hundred years was as promising for corporate performance as the last hundred years — the century in which the United States became a global economic power, the winner of the second World War, and the standard-bearer for the world (in its own mind, anyway), most Americans wouldn’t see the same kind of personal performance that financial planners advertise.
The kind of growth the United States saw in the twentieth century just doesn’t seem sustainable. Thinking globally, there still seems to be a lot of potential. But the economy in the United States has just become too expensive for the growth to happen here. I think that’s well understood, and people are looking internationally for growth opportunities, but this seems to be the point — it’s too expensive everywhere.
So maybe we just have to assume that long-term growth will be around 4 percent annually over the long term. No one wants to take this assumption because it causes problems with just about every financial planning model out there. Your “safe withdrawal rate” of 4 percent will fail, and inflation is a bigger risk.
The good news is that just doing something has to be better than doing nothing. If you invest 10 percent of your income into a stock market index fund for the long term over the next couple decades, it may only return an annual 2 percent, 4 percent, or maybe 6 percent. Well, there’s still the possibility of returns being higher. But even if they’re not, you’ll still be better off than those who have done nothing at all.
Start really thinking about the future.
The most promising way to make a future is to make it yourself. What are the biggest problems human existence will be facing in the next century? How can these problems be addressed? Apparently, there are enough people who believe that the availability of potable water is one of the problems humanity will face in the future. Scientists, including kids taking on middle school science experiments, are coming up with more efficient methods for cleaning water. It currently takes a lot of energy to turn ocean water into drinking water, and in areas of the world that don’t receive much rain, potable water is needed. This could lead to the growth of an industry in the next hundred years.
As the will for government spending continues to disappear, people will have to look to corporations to lead the way without government support. We may not get much from NASA in the next era, but private companies led by people who see some potential will pave the way for technological investment. The Internet is a product of twentieth century government funding, but that’s something that would never exist if the impetus was under today’s political climate. The next Internet, and by that I mean a world-changing technology, is going to be an opportunity that comes about only if the market deems it potentially profitable. And to take this further, the best opportunities will not be available to everyday investors; venture capitalists stand to gain from much of the potential economic growth of the next century.
We hear about the latest billion-dollar sale of technology companies, but most of these are backed — and therefore owned — by venture capitalists. So the smart kid who dropped out of college because he had a germ of an idea but pitched his business to venture capitalists will certainly see some financial benefit when he eventually exists the business, but it’s those who provided the capital who stand to win the bulk of the financial rewards.
So as much as I dislike the idea that average investors can now participate in angel investing through syndicates (because this is generally risky and sophisticated, and most investors don’t have enough wealth to manage risk and aren’t very sophisticated), this type of investing may be the only opportunity to see growth in the next decade. Angel investors take on risks, and usually they mitigate risk by diversifying across a large number of start-up businesses. These start-up companies may never see a time in which their stock is offered to the general public — or if they do, it will be after the initial investors take advantage of the early, most profitable period of growth.
Thinking about the needs of the future could give you insight not so much into where to invest, but where to spend your time. Or your life’s work. This may be more personally profitable than trying to invest 10% of your income into a certain industry or asset class.
Unfortunately, we have no way of predicting the future. Even the best minds have trouble coming up with what an industry will look like ten years from now. The automobile has lasted a hundred years. It’s probably a good bet that automobiles will be around for at least a few more decades. But after that, what will they look like? How will they be operated?
Google is betting on driverless cars. Tesla thinks the future is in purely electric vehicles. The traditional manufacturers and companies involved with the oil industry are the slowest to move. Will cars fly, like in Back to the Future? Probably not in 2015, but what about 2080? Someone is going to be right, and lots of people are going to be wrong. Those who are right will be the investors who experience the growth that is remembered — those who are wrong will be forgotten about and not included in historical accounts of a market. (That’s survivorship bias.)
Of course, there’s always a chance that no amount of planning will make a difference. Doomsday scenarios exist, even if they’re unlikely. Nature may change our ways of life in ways that we haven’t sufficiently planned for. But you can’t assume things that seem impossible. The best we can do is plan with the only understanding we have of the world today.
This may not solve the problem. Chances are good that people have already thought about what you see for the future, and that’s why professional investors can’t find any good, potentially profitable opportunities today. But if you take your ideas and start building something of your own, you’re creating your own value. Even if you don’t give birth to a new industry (kudos if you do!) you’ll be building value for yourself over the long-term, probably far better than an investment in any particular asset class will do for you.
Published or updated July 9, 2014.