Monday, June 05, 2006

Beating 10%

MelbournePhilosopher

Investing in the sharemarket is a game of trying to beat 10%. Historically, this has been the long-term return on Australian share investments. Bearish markets, bullish ones, recessions, depressions booms and busts simply vanish into the statistics over a long enough timescale. If you use a risk-minimisation strategy, and stick it out for long enough, you could reasonably expect a 10% return. (Source : http://www.asx.com.au/investor/pdf/getting_started_in_shares.pdf -- see the graph of expected returns). This is a compounding figure, so your absolute gains increase over time as you get interest-on-the-interest from previous years.

So, are you feeling lucky?

If you just buy one share, you're at the other end of the spectrum. Your money will experience far greater variance over time, as a single company is far more exposed to both danger and opportunity than the market as a whole.

Corrolory: If you buy a specific company, you are in fact using your money to wager that the returns will be greater than 10%. You are gambling with your money, risking a worse return in order to gain a better one.

If you don't have any reason to think a company will outperform the average significantly, don't buy it. If you want to get better than a 10% return, do a lot of research first.

Another way of thinking of this is in terms of the Red Queen problem. The Red Queen from Alice in Wonderland is forced to run as fast as she can just to stay in the same spot. The sharemarket is the same -- as soon as you're in, you're in a marathon race where in order to stay with the crowd you have to run. If you pace yourself, you should be able to finish somewhere in the middle. The pack is running at an average of 10% p.a. over the long term.

Things are, of course, a lot more complicated than this. There is more than one "rate" which you should be trying to beat. One is inflation, for example. If you are making less that inflation, then you really *are* going backwards as your money loses buying power. If you are making 6%, you are merely less ahead. However, it is the 10% rate against which one should primarily be assessing performance.

The basic reason for this is that there exist good strategies which make the 10% rate a very plausible target for any investor.

All share purchases are either attempts to reduce risk and thus achieve the 10% average, or to increase risk and beat the 10% average.

Cheers,
-MP

(This is not financial advice. I'm just this guy, you know?)

1 Comments:

Blogger Tomek said...

Interesting.. However, maybe the goal should be to beat say.. 15% or more? I say this because I have heard that the investment funds have about a 17% profit average fot he past few years.

6/09/2006 10:57:00 PM  

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