About Our Unique Investment Return Calculator

Question #1 on the new investment return calculator — What does the Return Predictor do?

The Return Predictor tells you what sort of long-term return you can realistically expect from an investment in the S&P index made at various valuation levels. For example, it reports that the most likely 20-year return for a purchase made today (this article was posted in February 2007) is an annualized real return of 2.6 percent. In contrast, the most likely return for a purchase made at moderate valuations is an annualized real return of 5.8 percent. The obvious strategic implication is that stocks offer a better value proposition at times of moderate prices than they do at times of high prices.

Question #2 on the new investment return calculator — What are the predictions based on?

The predictions are based on a regression analysis of the historical stock-return data (dating back to 1870). Valuations have always affected long-term returns in the past. The calculator assumes that this will continue to be the case in the future, and looks to the historical data to determine the probabilities of various outcomes. Precisely speaking, the calculator reports on the effect that valuations have had on long-term returns in the past.

Question #3 on the new investment return calculator — Is this calculator part of a market timing scheme?

It depends on how you define the word “timing.”

Investment Return Calculator

Many investors have heard numerous investing experts tell them that “timing doesn’t work.” There is indeed a good bit of evidence that short-term timing (trying to predict what stocks will do in one or two or three years) generally does not work. The new investment return calculator does not aim to help you engage in short-term timing.

The calculator attempts to predict long-term returns (returns achieved in time-periods of ten years or longer). What the calculator is really doing is assessing the long-term value proposition of stocks purchased at various price points. The price you pay for stocks obviously affects the long-term value proposition you obtain from owning them, just as the price you pay for any other asset affects the long-term value proposition you obtain from it.

Short-term timing does not work because it requires guesses about when stock prices are going to hit “bottoms” and “tops.” No such guesswork is required to practice long-term timing effectively. All that you need to do to practice long-term timing effectively is to assess long-term value propositions successfully and to make occasional changes in your stock allocation to reflect changes in the value proposition available to you.

Question #4 on the new investment return calculator — Do you sincerely believe that it is possible to predict future stock returns?

Yes, to a reasonable extent. If you have doubts about this, please do further research to either confirm your doubts or resolve them prior to making use of the new investment return calculator.

Question #5 on the new investment return calculator — If it is possible to predict long-term stock returns, why aren’t lots of other people doing it?

Lots of other people should be doing it. I think it is foolish for anyone to make a stock purchase (especially of an index fund) without first making use of some tool that assesses long-term value propositions.

The best explanation I can offer as to why most investors do not do this today is that easy access to the data and statistical tools needed to make effective predictions did not become generally available until recent decades, and, beginning in the early 1980s, the U.S. stock market entered a wild bull market that for many investors made it seemingly unappealing for a time to know how high prices affect the long-term value proposition of stocks. I expect to see calculators of this type become far more popular after we experience a big price drop.

Question #6 on the new investment return calculator — Are there experts who endorse this calculator?

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There are a good number of experts who endorse the principles used to build the calculator. Yale University Professor Robert Shiller (author of Irrational Exuberance) is the leading figure in this field of investing research. John Bogle, founder of Vanguard, says in his book Common Sense on Mutual Funds that: “This analysis takes into account my conviction both that the performance of individual securities is unpredictable, and that the performance of portfolios of securities is unpredictable on any short-term basis. While the long-term performance of portfolios is also unpredictable, a careful examination of the past returns can establish some probabilities about the prospective parameters of return, offering intelligent investors a basis for rational expectations about future returns.” William Bernstein says in his book The Four Pillars of Investing, that: “The ability to estimate the long-term future returns of the major asset classes is perhaps the most important investment skill that an individual can possess.” There are a good number of others who have written about the difference between short-term timing and determining long-term value propositions.

No expert has directly endorsed this calculator, however. Most of the experts who understand the difference between short-term timing and assessing long-term value propositions evidence a reluctance to putting those insights to practical use by advising investors when and to what extent to change their stock allocations in response to price changes.

Question #7 on the new investment return calculator — Who developed the calculator?

The statistical work was done by John Walter Russell. There is a wealth of cutting-edge investment research that relates to the investment return calculator available at John’s web site .

Rob Bennett’s contribution was to make a pest of himself by asking lots of dumb questions about how long-term stock investing really works. The leading theory as to why John is so generous in helping fellow Financial Freedom Community members with their investing questions is that he is hoping that someday he will have provided enough answers to enough questions that he will satisfy Rob’s curiosity re these matters. He probably does not yet fully appreciate what he is up against.

Question #8 on the new investment return calculator — How did the calculator come to be?

It all started with a post that Rob put to a Motley Fool discussion board on the morning of May 13, 2002. The post asked whether valuations affect safe withdrawal rates. That question set off the most exciting and the most controversial series of investing discussions ever held on Planet Internet. The Stock-Return Predictor is one of the fruits generated by the insights developed during The Great Safe Withdrawal Rate Debate.

Question #9 on the new investment return calculator — Does this calculator only help people who invest in the S&P index?

In a direct sense, yes. Those who are not invested in the S&P index can use the calculator to gain a general sense of how their long-term investment returns may be affected by the valuations that apply at any given time. But other types of stock investments may of course provide returns significantly different from what the S&P index provides.

Question #10 on the new investment return calculator — How can the calculator know what sort of things are going to happen to the economy before they happen?

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The calculator of course does not know what is going to happen. The assumption being used is that we will continue to see economic ups and economic downs somewhat similar to those that we have always seen in the past.

After the positive effect of the ups cancels out the negative effects of the downs, investors have in the past been left with a long-term annualized real return of about 6.5 percent. It has generally taken those who purchased at times of low or moderate valuations far less time to obtain that sort of return. The calculator seeks to inform you of the probabilities of obtaining various returns at various future time-periods, assuming that the economic realities remain more or less constant.

If you believe that U.S. companies will not be able to perform as well in the future as they have in the past, you should subtract something from the numbers generated by the investment return calculator to determine your own take on what is likely. If you believe that U.S. companies will be able to perform better in the future than they have in the past, you should add something to the numbers generated by the investment return calculator to determine your own take on what is likely.

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