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Investing - A Primer

This page is meant to give potential clients, or anyone who is interested, a quick overview of different asset classes, expected returns, volatility and just a basic introduction to the world of investments. This is meant only to give you a taste of what we will take the time to teach you about. We have MUCH more material and food for thought should you be interested in becoming involved with Tralucent. If you have ANY questions, thoughts, ideas or you simply want to discuss your day, please do not hesitate to contact us.

(Note: Figures are presented as Time Weighted Rate of Return. Information provided is not GIPS compliant)

The Three Basic Ways to Invest

The three basic ways of investing open to all people are: treasury bills, bonds and common stocks. Numerous investment strategies have been derived from these three basic assets.

In this primer, Tralucent has provided the last 89 years of US history (1926 – 2015) as an example to discuss what an investor may learn from studying historical returns.

Treasury Bills

The following graph shows the yearly returns of investing only in treasury bills:

 

Tbill Bar Graph as at Dec312015

Treasury bill investors lend money to the Government for less than a year and the Government gives them a return. At the end of the period, the lender turns around and lends it again at the new going rate. This rate may not be the same as the last one, and so is the source of some fluctuation. Some other forms of investments that are derived from treasury bills are GIC’s, Bank term deposits and the like.
History shows that the rates vary from year to year and that even these relatively safe investments can have varied returns. Indeed, they have varied from near zero during the depression, to 14% during the 80’s inflation, and back to near zero in 2011. Though it is worth pointing out – there has never been a negative year.

If our great-grandfathers had started a trust account
for their great-grandchildren then that account would have grown every year, though not always at the same rate. This trust account, starting with $1 in 1926 would have grown to $20.59 by the end of 2015. In 1926, the average salary was $1313. Now, assuming it was one year salary he had set aside for us, that salary would have grown to $27,060. There is never a down year and with a compounded annual return of 3.45%, the money grows quite steadily.

We could afford a tract of a forgotten beach somewhere it is not that warm.

What $1 invested in 1926 Treasury Bills grows to:
T-bills as at Dec312015

Corporate Bonds

The following graph shows the yearly returns of investing only in bonds:

Bonds Bar Graph as at Dec312015

Here investors lend money to governments, corporations, municipalities and the like for terms longer than a year. They are paid a certain amount (interest) every six months and then the entire principal is returned at the end of the term. This interest varies from time to time and that causes fluctuations in returns. Nonetheless, over the 89 year period corporate bonds have provided a compounded annual return of 6.01%, with 18 years where the return was negative, proving that there is nothing fixed about fixed income. Out of these 18 negative years, the highest negative return was 8%. Bonds are very useful for situations where low volatility is desired, but a steady return can not be assumed.

Back to that same trust account
started by our great-grandfather: that account would have grown most years, though not always at the same rate. One dollar invested in 1926 would have grown to $179.69 by the end of 2015. Again, assuming he has set aside one year’s salary of $1313, had it been only invested in bonds, the current value would be $235,933. With the exception of a few periods where your family would be scratching their heads as to why the returns were negative, when they are supposed to be positively fixed, your money would grow quite steadily with a compounded annual return of 6.01%.With this, you could afford a decent house around Bathurst, New Brunswick or make a good down payment on a house around High Park, Toronto.
What $1 invested in 1926 Corporate Bonds grows to:

Bonds as at Dec312015

 

Common Stocks

The following graph shows the yearly returns of investing only in stocks:

Stocks Bar Graph as at Dec312015

Investors buy shares in companies trading in recognized stock exchanges. Some stocks pay dividends, and some do not. Their prices fluctuate widely which creates huge variations in returns. Some years are extremely painful, with stocks having gone down by 30 or even 40 percent. In some cases they even go down some more the next year, causing extreme anxiety. Then, there are some years they go up by 50% to be followed by another year or two (or three) of very strong returns. Another fairly common scenario is where there is year that markets are up by 50%, to be followed by near zero return, followed by large declines such that there is a five year period where there was no progress to speak of. Yet, it is unthinkable that a diversified portfolio will become ZERO.

A compounded annual return of 10.14%, but the huge variation from year to year makes a mockery of the term average. Approximately 24 of the 89 years shown have been negative, and some quite severely. All these ups and downs makes one wonder – is it a stock market or a soap opera?!?

Back to that trusty trust account,
if our great-grandfather had invested only $1 in 1926, then that account would have grown and shrunk over the years, but growing more than shrinking overall. This measly $1 would have grown to $5422.84 by the end of 2015! Assuming instead it was the one year salary of $1313 he had set aside for us, the same money would have grown to $7,120,189! Granted, this growth would have been full of drama, anxiety and pain; yet it would allow us to buy at least a nice vacation property in Cayman Islands, if not more. Perhaps such experiences are best captured by the phrase – no pain, no gain.
What $1 invested in 1926 stocks grows to:

Stocks as at Dec312015

 

Long term returns, the drama, pain, and joy:  Over long periods of time, the Stock market with a return of about 11% has been the best performing asset classes (I refer of course to the information above – where we present its history and how it has outclassed other asset classes). However, the stock market is packed with drama, theatrics, pain and joy. Below we have outlined how stock markets move so you may get a better feel for what happens.

The Pain AND Joy in the stock market


First, the pain:

Level 1 Corrections: 7 to 10% declines happen just about once a year. It is almost a routine.  Please expect them.

Market returns are lumpy. This means that in many cases returns occur in a relatively short period while the market then goes sideways or even down creating zero returns over months and quarters. You may consider this as sort of Level 1 Corrections as well.

Level 2 Corrections: Even 10-20% declines happen just about every 18 months and may happen swiftly within months. Every time something like this happens, it may wipe out months of  gains and even years.

The math is simple. Imagine the market over a two year period has risen 20% and then in months it declines 20%. Net result is that two years gains are gone. Please do not be astonished when such a thing happens and in fact expect them every now and then. Similar math and sequence of events will then even result in one year gains to dissipate. Again, please do not expect yearly gains or gains every twelve months either.

Level 3 Corrections: Declines greater than 20% take place on average every four to five years as well. They wipe out years of gains sometimes even making four and five year returns as zero. We guarantee, something like this will happen again as well. Please expect such declines and do  not expect gains even every four years either.

Level 4 Corrections: Even 50% declines from top to bottom take place every ten to 15 years leaving even a decade long return to zero. Please bear even this aspect in mind.


The Joy:

The purpose of the above is not to discourage you or to frighten you but to explain the nature of the stock market and to add to your knowledge. Now that you are aware of corrections and declines, You must then also realize that 7-10% up movements are also routine and far exceed the declines; stocks climb 20, 50 and even 100% in short periods and the up movements far exceed the down to then produce the 11 % returns over long periods of time – Returns so stellar that they handily beat other asset classes and inflation.

Earlier we noted that every now and then even four year returns may be zero or nonexistent. However note that four year returns that handily beat anything else are even more routine – one only has to think long enough.

Every now and then even ten year returns may be zero but the good news is that it is not that frequent that ten year returns did not beat other asset classes hands down.

Even more interesting is that such gains have come about through wars, recessions and depressions, political upheavals etc., etc. Obviously, declines were an opportunity to add to holdings and to be patient.

 

We repeat one of our most favorite pictures —long term returns from Large Cap US stocks. One glance at the picture and you will also conclude that the above observations are quite correct. Most one year and four  and ten year returns are positive and something to celebrate…One only needs to think long term and be patient.

 

Camparison chart

 

Your Unanswered Questions

The above is a simple primer to get started thinking about investing in public markets. It does not answer numerous questions that most are likely to have such as:

1. How do these returns stack up against inflation,
2. How to look at volatility during the year,
3. How to handle volatility,
4. How should you look at markets if you were planning for your great-grandchildren,
5. How should you look at markets if you were planning for the next 3 or 5 or 10 years.

This is where you may call Tralucent for a discussion as to how we may be able to help.