No one knows what the future holds

Amen, predictions can be difficult especially ones about the future.  No one knows what is around the bend.  Financial planners like me make projections based on past results but isn't that like driving your car looking in the rear-view mirror?  Real estate folks like to say this is the time to buy, if so, why are they selling the property to you?  Hopefully there is a light at the end of the tunnel and lets hope it's not Casey Jones highballing down the track.

Visit www.efficientfrontier.com the web site of Dr. William Bernstein.  Dr. Bernstein wrote a brilliant treatise on why capitalism (and democracy) blossomed in Western Europe. His book-A Splendid Exchange-delves into why a "fertile crescent" from Genoa to Glasgow was so critical to improving society over the last 400 years.

In the June issue of Money we find the good doctor analyzing current affairs. In his column The Intelligent Investor he points out that most stocks lose money. Not just last year, either.  To wit, three-fourths of the US stocks collectively lost 2 percent annually since 1980 as measured by Dimensional Fund Advisors research.  However if you include the top quartile the collective annual return sprouts to over 10 percent annually.  

Stock pickers (clients and fund managers) profess their ability to load up on the highfliers.  The problem with that strategy is missing only a handful of winners can leave you coming up short.  Your goal should not be to amass a fortune rather to avoid the poorhouse.  

Without a doubt the best way to diversify is to use index funds.  You may want to ask a professional's advice to make sure you are on the right track.  The only way to own tomorrow's best performing assets classes is to use a mix of US and international index funds.  Fixed income always has place, if you haven't had that "Come to Jesus moment" it's not too late, brother.

The truth is stocks are a loser's bet...unless you own the market.

Flipping over to the June issue Financial Advisor we find mention of an obscure prognostication tool-The Gordon Equation. Bernstein mentions this tool in another of his nifty books, The Four Pillars of Investing.  Essentially this equation postulates that future equity returns are the sum of the market dividend yield and the market's long term dividend growth rate.  Around 2000 the Gordon equation predicted much lower future returns. Conversely it previously peaked in the early 1980s. History shows us what followed. 

What's it saying now?  Well, it depends.  First the equation is more a long range forecast.  Before you discount that, ask the weatherman what the weather will be like in ten years.  The equation has been fairly accurate when you have a ten year or longer window. 

More importantly is what constitutes dividend growth rate.  Again, it depends.

1945-2008 6.2 percent, 1979-2008 5.7 percent, 1877-2008 3.5 percent are three historical rates.  Added to 2008 yield of 3.2 percent we get a future return of 6.7 to 9.4 percent.  I will do back flips for those returns. Folks from Auburn will like that, too. They won't have to count on their toes.

There are few guarantees in life. Dr. Bernstein calls the Gordon equation "not too shabby" as a forecasting tool.   From 1900-1999, the average dividend yield was 4.5 percent and dividend growth was the same. For that period equities returned 9.89 percent, close enough for me too, doc.

Don't forget the equation predicted high returns in the early 1980s and more subdued returns in the late 1990s and early 2000s.   But it only works if you own the whole market.  Like I explained to y'all before it's a long range tool and in the long run we will all be dead.

 Buz Livingston is a certified financial planner. He operates Livingston Financial Planning Inc. focusing on hourly financial planning and investment management. Contact him directly at (850) 267-1068 or at LivingstonFinancial.net.