Vanguard Life Strategy

bowlhead99

JohnRo wrote: »

Inflation adjusted it's closer to 40% off

Enlighten me: what is the point of -

- taking an asset that produces income (like a portfolio of largecap shares)
- pretending the income doesn't exist and is not reinvested
- and then saying what you're left with isn't much because in real terms it is losing 3% a year to inflation.

It is producing 3% a year in income !!!!!!.

JohnRo

I'm responding to the assertion that the capital value of the "FTSE" is 15% off it's all time high, which is wrong.

I'm not adjusting for income or reinvestment because it's not relevant.

The assertion by bottleandahalf is that the FTSE index isn't that far off it's peak and by implication, unless I misunderstand, that it would be wiser to hold cash right now, ready for when the index valuation crashes and burns.

I'm trying to show that historically the FTSE index valuation is a long way off it's peak, when inflation adjusted, and no where near the sort of peak where a crash might be expected.

bowlhead99

JohnRo wrote: »

I'm responding to the assertion that the capital value of the "FTSE" is 15% off it's all time high, which is wrong.

I'm not adjusting for income or reinvestment because it's not relevant.

The assertion by bottleandahalf is that the FTSE index isn't that far off it's peak and by implication, unless I misunderstand, that it would be wiser to hold cash right now, ready for when the index valuation crashes and burns.

In the case of the FTSE, you can say that the capital value of the index is already some sort of inflation adjusted measure of total return of the index, because eliminating the 3% dividend approximates to eliminating the 3% inflation. So you don't need to adjust it again for inflation. But you say you're not looking at returns but just price at a point in time - so OK, I'll try a different tack:

In your last sentence you mention the key word - the index *valuation*. The value of the FTSE isn't 6162 just for fun. It's 6162 because all the market participants valued all the stocks and came up with 6162. How did they do that valuation? Well, a variety of methods depending on what was relevant and appropriate for the particular company. Maybe looking at am earnings multiple on recent or forecast earnings, or a discounted future cashflow analysis, or an assets multiple, or some combination.

So what is the valuation metric for all the companies? Price over earnings. Price over cashflows. Price over assets. It is price over a denominator. And the nominal value of those denominators are things that should change with inflation over time (the overall earnings made by a company in a year; or what amount of cash it gets in the door for selling a widget versus the cash it paid out the door for its labourforce; or the cost or value of the company's productive assets).

To provide some feedback to bottleandahalf on whether the valuation is high or low you have gone and taken the price of 6142 (the 'x' in the 'x over y' calculation... just ONE of the items...) and discounted it for inflation.

To determine an inflation-adjusted valuation, you would have to discount both the price AND the earnings projection - or assets, or whatever other element that is your preferred basis of fundamental measure when performing the valuation - for the inflation rate.

Effectively you are just saying, "hmm, the price is £6162, what is £6162 in April 2015 pounds or in December 1999 pounds or 1980 pounds? Oh, that seems expensive, or that seems cheap, compared to what the price used to be." But price is only one half of the 'valuation' metric and I don't see you considering what the other components of the valuation even are, let alone discounting them for inflation.

So, I don't really like the concept of drawing a picture of an 'inflation adjusted capital value of the stock index' which we see pasted on these forums from time to time to see whether returns have been good or whether the price is cheap.

It tells you nothing about your returns because it is missing dividends. It tells you nothing about whether things are valued expensive or cheap compared to their intrinsic value because it doesn't show the earnings or the assets of the companies to know if the price is relatively high or relatively low compared to those earnings or those assets. Bottom line, I don't like it, because it doesn't really serve a useful purpose, so I complain when it comes up.

bottleandahalf wrote: »

The FTSE is about 15% off it's highest peak ever, so who knows if it will go up 20/30%?

I know what you're saying about time out of the market lowering returns but I'm just thinking if you were to put all the cash in now at the point the markets are presently at, it may also lower returns as they haven't ever soared 15/ 20, 30% higher than their present levels.

If markets moved up in a straight line at 7% a year or whatever, then every single day the market was open you would be paying an 'all time high' price for the shares, but you would never be wrong to do it. So there is nothing inherently wrong with buying at a high price.

If you keep 20% of your money in cash you will just get the returns of 80% shares and 20% cash. Say you have £800 shares £200 cash.

So if markets deliver +25% and cash delivers +2%. Your portfolio becomes worth £1000+£204 = 1204. Then the next year the markets deliver -25% and cash delivers +2%. Your portfolio becomes worth £750+ 208 = £958.

Or, start again, If markets deliver -25% and cash delivers 2% your 800:200 portfolio becomes worth £600+£204 = 804. Then the next year the markets deliver +25% and cash +2% so your portfolio becomes worth 750 + 208 = £958.

If you didn't have the cash component your 1000 shares would go to 1250 and back to 938 in the first scenario and down to 750 and up to 938 in the second scenario.

In both cases, you lost money from your 1000 because the overall return from equities over the two years was negative and the equities was the biggest part of your portfolio. The return was better when holding a bit of cash because the overall return from cash was positive and the equities wasn't. Over a two year period anything can happen. But the size of the swings is important. Equities only topped out at £1250 or bottomed out at £750 depending on the order things happened. Equities and cash mixed topped out at £1204 and bottomed at £804.

So if you can't handle the risk and volatility (large and frequent swings) you should not have an equities heavy portfolio. You will get a smaller range of potential outcomes if you don't have as much money in equities and have more in cash instead, and you might prefer that. But what you are wondering is, should I hold cash and then switch it to equities when equities are cheap and get 100% of the equity rise having only suffered 80% of the equities loss.

Well yes of course it would be nice if you could do that. But what happens if it is the other way around and instead of getting the loss followed by the gain, you get a gain followed by a loss? That would result in you getting only 80% of the gain, switching the last bit of cash over to equities (because ultimately you do intend to be fully invested and you can't wait forever) and then taking 100% of the loss. Clearly that's not ideal - your caution hasn't been rewarded and instead you were penalised for it by having greater losses as well as missing out dividends.

And your problem is you can't know when the loss is coming. As other people mentioned, the market might go up nicely before correcting downwards to something that is no cheaper (perhaps more expensive) than today.

At one point the houses on my street had never sold for more than £50,000. Would you have been crazy to buy at £45,000? How about when the houses had never sold for more than £300k, was it silly to buy at £275k because it was close to the top price that had been achieved and might go lower instead of going up? The prices didn't go back from £275k to £50k they went up instead, and some are offered at £1m+ these days, so they could have a 50% crash and still be much more valuable than they were when some people turned them down at £275k or £45k. They have been a good investment for those who picked them up rather than waiting for the next drop. Like a share delivering capital growth and dividends, they delivered capital growth and rent income or rent saving depending on your circumstance.

So, by all means stay partly in cash to give you a less volatile portfolio result (i.e. the swings of £804 to £1204 instead of £750 to £1250) ; and you could use something other than cash as the 20%, like bonds or property funds) but in the long term you know that the 2% return from cash or those more stable assets is going to be dwarfed by the bigger return from equities, so you are just playing a timing game and it is very difficult to know how to win that, otherwise we would all do it.

There is certainly some sense in having a portfolio that is not 100% equities as by holding assets in different sectors and 're-balancing' every so often you will inherently buy assets which are cheap (to top them up) with proceeds from selling assets which are expensive (to bring their proportion of your portfolio back down to your target). So this can be good for returns while giving less overall volatility.

But don't confuse "holding money in cash waiting to pounce" with having a proportion of your portfolio in bonds and property and cash waiting to 'rebalance'. The concepts are perhaps the same in terms of how you make money by buying low, if you can - but the former (which is what you are suggesting) implies some psychic ability because you know you will get a great buying opportunity much better than today's prices to make it worth your while waiting. Tell that to the people who didn't buy houses at <£50k or FTSE at 1000 because they thought it was looking quite close to peak prices.

JohnRo

The chart tells nothing of returns because they're irrelevant. A snapshot in time of the capital value of the index doesn't have to factor earnings, returns, ratios or anything else, those things aren't being measured or compared, as for all the other stuff you're talking about they are all priced in to the valuation at the time anyway.

Adjusting for inflation might be crude but how on Earth can it be done otherwise? It's adequate to show that the stock market valuation in today's money during the 2000 and [STRIKE]2008[/STRIKE] 2007 peaks was much higher than it is now, relatively.

I'd argue now is a good time to be investing in the UK market, if anything, based on those historic peaks. Anyone sitting on cash now waiting for an impending UK stock market crash could have a very, very long wait.

You've made a very long post that goes around the houses but I think you eventually agree.

bowlhead99

JohnRo wrote: »

The chart tells nothing of returns because they're irrelevant. A snapshot in time of the capital value of the index doesn't have to factor earnings, returns, ratios or anything else, those things aren't being measured or compared, as for all the other stuff you're talking about they are all priced in to the valuation at the time anyway.

Vendor: Here is something you can buy. Would you like to buy it?

Prospective buyer: I don't know, what is it. What do I get for my money? For my £2 trillion of cash, am I buying a portfolio of companies that produce £200 billion of income each year? That would sound OK. But if I'm buying a portfolio of companies that only produce £1 billion of profits a year, that sounds bloody expensive.

Vendor: The price in real terms is less than it used to be. It used to cost £3 trillion and now it's only £2 trillion. So it's a screaming bargain. Buy it.

Buyer: But what was being sold then was different from what was being sold now. Surely what I get for my money is just as important as the amount of money I pay. Why will you only tell me the price I must pay and say it's cheap? A Mars Bar for £1 is only 95p in yesterday's money so yes that's a lower price in 'real terms' than the 96p it cost a couple of years ago, but Mars Bars used to be sixty grams of food and now they're only fifty grams of food, so it now costs more per gram in real terms, not less. The price on its own does not tell me the thing is cheap or expensive if I don't know what the thing actually is.

Vendor: No, what you are buying does not matter. My experts say it's the right price and you can see the price is less than it used to be. So it doesn't matter what the contents of the package is. Just buy the package now because the package used to cost more so it is definitely not overpriced now.

Buyer: Are you for real? How can you say taking a snapshot of the price on the packet tells you that it's a better deal than it used to be, if you won't tell me what's in the packet. For all I know the packet used to contain two Mars Bars at 60 grams each and I was getting 120g of lunch for 96 pence, and now it only contains one New Mars at 50g of lunch for 95 pence. That would be a terrible deal

Vendor: no no no. I don't have to factor in the volume or the quality of the chocolate or the earnings or the assets or the price per gram of chocolate or pound of earnings. I just need to say that someone was once willing to pay more than £2 trillion in real terms for this bag of sweets or companies. It doesn't matter if those companies were better or worse than they are now. Just please note the price, which is lower, and you can see it's a great deal.

Buyer: Nonsense. The price stamped on the packet ells me nothing, what am I buying. I ask again, what do I get in the packet today!? Am I paying a lot or a little *for the things in in the packet that I'll want*. It seems a con to just say the price is lower without telling me what is in the packet that I'll want and is it the same as what used to be in the packet.

Vendor: Sir, the contents of the packet aren't being compared. There is no need to look at amount of chocolate in the packet, number of potential competition prizes or discount coupons in the packet, or earnings, returns, ratios or anything else. They are not your concern. I am just telling you the packet is not overpriced or even close to being overpriced, because it used to cost more money. Whether that's more or less money per pound weight of chocolate or pound sterling of assets and income streams held by the packet, I'm not at liberty to say. But you can see that the price I want you to pay is lower than I once asked, so it's a good deal, and not overvalued, it is cheap, because if you adjust for inflation I used to charge more for a packet.

Buyer: I can see no business will get done here today if you insist that the price of something is the important thing and not what you get for your money.

Vendor: A misconception, sir. The price per item is correct. Analysts determine the price and the market is always right. Now is a cheap time to buy, it's 40% cheaper.

Buyer: the price wasn't right in 1999 or 2008 so people lost their shirts. They should probably pay attention to what they get for their money. How do I know I won't lose 40% like they did? I might be overpaying even more than they did, if I only look at price of the packet and not price per [useful or delicious contents] of the packet. Your graph of what you charge for a packet is meaningless without knowledge of what's in it.

Adjusting for inflation might be crude but how on Earth can it be done otherwise? It's adequate to show that the stock market valuation in today's money during the 2000 and 2007 peaks was much higher than it is now, relatively.

You are not giving any valuation information ("valuation in today's money"). You are only saying the *price* in today's money is cheaper. The important thing is the valuation which can not be seen from a price graph.

Anyone sitting on cash now waiting for an impending UK stock market crash could have a very, very long wait.

I agree and said so in my post.

Your pretty price chart is not very useful for informing that decision though as it doesn't allow a meaningful conclusion to be drawn.

JohnRo

You're barking up the wrong tree. Quite what the bag of treats analogy has to do with a constantly shifting index is beyond me.

As the contents of the index change they're all approximately included in the asking price at the time. The index itself doesn't change in that it is, in the case of the UK 100, the top 100 UK companies.

It's quite reasonable to compare the top 100 then with the top 100 now in terms of a value as indicated by the index. That's a value based on the GBP cost to buy, so requires some account to be made of the dwindling buying power of the currency used to purchase if a meaningful comparison is to be made.

The question is not what's in the index, we know what's in it, but what it says about the current state of that particular market and whether relatively it's current level is high or low. It will rise and it will fall, the historic reference, rebased, gives at least some indication where it's currently at in relation to those historic values which mean absolutely nothing without the inflation adjustment.

bowlhead99

Ah well, we'll have to disagree.

If people were paying 50x earnings or 100x net assets in 1998 or 2007 and now they are only paying 3x annual earnings and 1.5x net assets in 2016, that implies the basket of companies is cheap for what you get (the recurring flows of earnings supported by assets), relative to what people have paid in the past for what they stood to get.

As long as the earnings are sustainable and the assets aren't all being eroded by heavy losses, then the VALUE today (x times earnings or y times assets or z times discounted cash flow projections) is clearly pretty nice compared to the past when I had to pay a higher multiple of those key metrics, and does not imply any "overvaluation".

But the PRICE today doesn't tell you the value today and whether it's competitive. The price might be a large or small absolute number compared to the absolute number in the past. The price is simply a sticker slapped on an item on the shelf. You are saying you know what the item is, it's a box of companies, so just tell me the price, that's the important thing.

I would rather pay £100 for £99 of recurring annual profits than pay £50 for £1 of recurring annual profits. You would rather pay £50 because the "inflation adjusted price" is half what it used to be and there's nothing further to ask.

To me, I don't care that the price dropped, because I don't care how many "units" my statement says I bought. I care how many productive assets I bought and how much sustainable ongoing earnings I get for the £10000 I plan to invest. If I don't get much in the box I'm considering buying off the shelf , I don't want to pay a high or even a medium price for the box. Regardless of what someone paid for a box called "FTSE100" in the past, I may need a much much lower price or I risk a catastrophic loss and have a high chance of losing money when the market comes to its senses.

Your rationale is that with your £10000 you get 1.64 indexes for your money when the price is 6100 this week and you only got 1.43 indexes for your money when the price is 7000 last year so it is definitely better to buy now when the price is low on an inflation adjusted basis. You are getting more units for your money today so in your little bubble, all things being equal, you think that is good value.

Unfortunately all things are not equal and you are not even attempting to "value" anything, you are just saying it is a cheaper price so it is better and there's a lower risk of loss because the index isn't at a high. An actual "value investor" like a Warren Buffett would say you have no idea of what you're doing.

I don't intend that as an insult as clearly you have been investing a while and have made plenty of sensible comments on loads of threads. But price is irrelevant. I once had a lloydstsb share that had a price of £6. Inflation adjusted, even higher. I bought one the other month for 60p. It is a different business now. So it is cheaper in real terms but not necessarily a ten times more more attractive "valuation".

JohnRo

OK point taken, the index is a price not a value. My mistake.
The only reason I posted the chart was to show that the index isn't 15% below it's all time high price

Value will require a chart of CAPE, but that's another subject which courts controversy if I recall.

I'll slink off back under my rock.

bowlhead99

Hehe, I think CAPE charts are probably available if someone wants to go back through the last 35 pages /1400 posts. CaPE on its own, like regular PE on its own or other stuff on its own, is of course a flawed measure for judging value and open to all sorts of criticism. It is at least a measure of value of some sort, whereas 'price' is not value, 'price per something' is value IMHO

Anyway, this is a thread about investing passively in a particular collection of index funds under a particular brand name ; one would only invest purely passively if they were comfortable that the price is always generally about right. As such - the price can't be any better or worse than it was before because the market always fixes itself so that it's generally about right.

Therefore, there is no point trying to miss a market drop through timing. Unless you're confident, and want to have a go at doing just that.:D

Zola.

Great thread this.... I am 30, and have been investing in LS 80 for a short while. I plan to hold it for as long as possible with regular monthly payments. I hope in 20-30 years it will still be relevant and successful, and of course that I am still around haha..


Obviously no one can predict the future and there will be all sorts of peaks and falls, but do you think over 20 years it would be fair to expect an average of 5% a year interest / growth? Is that unrealistic, or too conservative?

I am just playing around with a compound calculator and trying to work out what I would need to be putting in every month to hit my long term target.