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  • CM CM 
    Participant
    Status: Physician
    Posts: 999
    Joined: 01/14/2017

    The historical mean return is based on the historical average valuation. When valuation is not equal to the historical mean, expected returns are not equal to the historical mean, just as the mean survival for someone with metastatic lung cancer is not equal to the national mean for that someone’s age and gender.

    Larry Swedroe recently alluded to a paper by Cliff Asness (Swedroe here: https://www.etf.com/sections/index-investor-corner/swedroe-expected-vs-realized-returns?nopaging=1 and Asness here: file:///C:/Users/Curt/Downloads/An%20Old%20Friend%20The%20Stock%20Markets%20Shiller%20PE%20(1).pdf ):

    “In a November 2012 paper, “An Old Friend: The Stock Market’s Shiller P/E,” Asness, of AQR Capital Management, found that the Shiller CAPE 10 provides valuable information. Specifically, he found 10-year-forward average real returns drop nearly monotonically as starting Shiller P/Es increase.

    He also found that, as the starting Shiller CAPE 10 ratio increased, worst cases became worse, and best cases became weaker. Additionally, he found that, while the metric provided valuable insights, there were still very wide dispersions of returns. For instance:

    • When the CAPE 10 was below 9.6, 10-year-forward real returns averaged 10.3%. In relative terms, that is more than 50% above the historical average of 6.8% (9.8% nominal return less 3.0% inflation). The best 10-year-forward real return was 17.5%. The worst 10-year-forward real return was still a pretty good 4.8%, just 2.0 percentage points below the average and 29% below it in relative terms. The range between the best and worst outcomes was a 12.7 percentage point difference in real returns.
    • When the CAPE 10 was between 15.7 and 17.3 (about its long-term average of 16.5), the 10-year-forward real return averaged 5.6%. The best and worst 10-year-forward real returns were 15.1% and 2.3%, respectively. The range between the best and worst outcomes was a 12.8 percentage point difference in real returns.
    • When the CAPE 10 was between 21.1 and 25.1, the 10-year-forward real return averaged just 0.9%. The best 10-year-forward real return was still 8.3%, above the historical average of 6.8%. However, the worst 10-year-forward real return was now -4.4%. The range between the best and worst outcomes was a difference of 12.7 percentage points in real terms.
    • When the CAPE 10 was above 25.1, the real return over the following 10 years averaged just 0.5%—virtually the same as the long-term real return on the risk-free benchmark, one-month Treasury bills. The best 10-year-forward real return was 6.3%, just 0.5 percentage points below the historical average. But the worst 10-year-forward real return was now -6.1%. The range between the best and worst outcomes was a difference of 12.4 percentage points in real terms.”

    The current CAPE 10 (or PE10) is about 31.38 (from Robert Shiller’s spreadsheet, available online).

    I generally estimate returns as the dividend yield plus about 1.55% (approximate LT real earnings growth from Shiller’s spreadsheet; Siegel found only 1.25%), so 1.96% + 1.55% = 3.51% (total real return). I then apply a haircut for a lower mean future valuation relative to today.

    Click to expand…

    That’s really just another guess, Mumbo jumbo. No one knows, and there is no accurate model.

    Click to expand…

    Returns are comprised of:

    1. Dividend yield

    2. Growth (of earnings, dividends, or cash flow)

    3. Change in valuation

    That isn’t mumbo-jumbo; it’s just arithmetic.

    If the current valuation is higher than the historical valuation, then future returns must be lower than historical returns unless growth is greater than the historical mean (in this case much greater), or unless the future valuation goes even higher.

    If you believe future returns will match historical returns, then you are stating one or the other, whether you realize that or not.

    Erstwhile Dance Theatre of Dayton performer cum bellhop. Carried bags for Cyd Charisse (gracious). Hosted epic company parties after Friday night rehearsals.

    #205045 Reply
    Avatar Tim 
    Participant
    Status: Accountant
    Posts: 2075
    Joined: 09/18/2018

    @lordosis,
    You forgot one or two factors.
    Great job in defining your risk capacity and risk tolerance.
    1) About that income capability. You didn’t mention a biggie, the DI insurance, life insurance, malpractice and umbrella policies.
    Those let you tolerate a higher AA.
    2) My only question is are you taking more than you need? Not really convinced you have noodled that one around enough. With the time horizon, you haven’t needed to address that completely.

    #205046 Reply
    fatlittlepig fatlittlepig 
    Participant
    Status: Physician
    Posts: 667
    Joined: 01/26/2017

    It’s mumbo jumbo, no one knows what future return will be, anyone who claims to is a fool, the stock market is not a math equation with growth, earnings as variables, it’s a unforeseeable entity as you also have psychology, market sentiment, emotions as variables. If you could accurately forecast that market returns will be so and so for the next 10 years go ahead and sell calls against the market for the next ten years.

    #205050 Reply
    Avatar Perry Ict 
    Participant
    Status: Physician
    Posts: 33
    Joined: 01/20/2019
    Splash Refinancing Bonus

    The historical mean return is based on the historical average valuation. When valuation is not equal to the historical mean, expected returns are not equal to the historical mean, just as the mean survival for someone with metastatic lung cancer is not equal to the national mean for that someone’s age and gender.

    Larry Swedroe recently alluded to a paper by Cliff Asness (Swedroe here: https://www.etf.com/sections/index-investor-corner/swedroe-expected-vs-realized-returns?nopaging=1 and Asness here: file:///C:/Users/Curt/Downloads/An%20Old%20Friend%20The%20Stock%20Markets%20Shiller%20PE%20(1).pdf ):

    “In a November 2012 paper, “An Old Friend: The Stock Market’s Shiller P/E,” Asness, of AQR Capital Management, found that the Shiller CAPE 10 provides valuable information. Specifically, he found 10-year-forward average real returns drop nearly monotonically as starting Shiller P/Es increase.

    He also found that, as the starting Shiller CAPE 10 ratio increased, worst cases became worse, and best cases became weaker. Additionally, he found that, while the metric provided valuable insights, there were still very wide dispersions of returns. For instance:

    • When the CAPE 10 was below 9.6, 10-year-forward real returns averaged 10.3%. In relative terms, that is more than 50% above the historical average of 6.8% (9.8% nominal return less 3.0% inflation). The best 10-year-forward real return was 17.5%. The worst 10-year-forward real return was still a pretty good 4.8%, just 2.0 percentage points below the average and 29% below it in relative terms. The range between the best and worst outcomes was a 12.7 percentage point difference in real returns.
    • When the CAPE 10 was between 15.7 and 17.3 (about its long-term average of 16.5), the 10-year-forward real return averaged 5.6%. The best and worst 10-year-forward real returns were 15.1% and 2.3%, respectively. The range between the best and worst outcomes was a 12.8 percentage point difference in real returns.
    • When the CAPE 10 was between 21.1 and 25.1, the 10-year-forward real return averaged just 0.9%. The best 10-year-forward real return was still 8.3%, above the historical average of 6.8%. However, the worst 10-year-forward real return was now -4.4%. The range between the best and worst outcomes was a difference of 12.7 percentage points in real terms.
    • When the CAPE 10 was above 25.1, the real return over the following 10 years averaged just 0.5%—virtually the same as the long-term real return on the risk-free benchmark, one-month Treasury bills. The best 10-year-forward real return was 6.3%, just 0.5 percentage points below the historical average. But the worst 10-year-forward real return was now -6.1%. The range between the best and worst outcomes was a difference of 12.4 percentage points in real terms.”

    The current CAPE 10 (or PE10) is about 31.38 (from Robert Shiller’s spreadsheet, available online).

    I generally estimate returns as the dividend yield plus about 1.55% (approximate LT real earnings growth from Shiller’s spreadsheet; Siegel found only 1.25%), so 1.96% + 1.55% = 3.51% (total real return). I then apply a haircut for a lower mean future valuation relative to today.

    Click to expand…

    Thank you, CM, this is a valuable and insightful post, and exactly the type of info I look for when I make any investing decision.

    #205053 Reply
    Liked by CM
    ENT Doc ENT Doc 
    Participant
    Status: Physician
    Posts: 3008
    Joined: 01/14/2017

    Savings rate > Asset allocation

    I don’t go higher than 6% nominal in any of my modeling.

    #205054 Reply
    Avatar Tim 
    Participant
    Status: Accountant
    Posts: 2075
    Joined: 09/18/2018

    https://awealthofcommonsense.com/2019/04/dividends-dont-matter-as-much-as-they-used-to/

    Doug Short and Robert Schiller’s work is interesting.

    Stock buy backs are relatively new and greatly impact virtually every valuation measure.
    https://aswathdamodaran.blogspot.com/2019/02/january-2019-data-update-8-dividends.html?m=1

    It’s kind of amazing that no one has been able to come up with and predictive system or model. It’s interesting, but can’t predict the future.

    #205055 Reply
    IntensiveCareBear IntensiveCareBear 
    Participant
    Status: Physician
    Posts: 129
    Joined: 12/22/2018

    [income from stocks, ie covered calls] is investing.

    Click to expand…

    That is picking up nickels in front of this: https://www.cat.com/en_US/products/new/equipment/compactors/tandem-vibratory-rollers/1000027460.html

    Sure the roller is moving slowly, yeah your fast picking up those nickels, but only one misstep and you get run over and wiped out financially speaking.

    Click to expand…

    Please, do enlighten me. Show me how someone selling covered calls on quality ETFs or stocks they like owning gets steamrolled. I implore you.

    If I own 500 shares of VTI (total US market index ETF) and it is at $148 per share today (Apr 8th)…

    I sell a covered call for exp date April 18th at strike price of $150 for 20c per share. I instantly get $100 (20c per share x500) in my acct.

    Ten days (8 market days) later, on exp date (morning after, but that is minutia), one of three things will happen:

    1) VTI is trading same price ~148, and I keep the shares. I’m up $100 (0.14%) in ten days, . I can sell a call again if I want.

    2) VTI is down under $148, and I keep the shares (just like a buy-and-hold)… but I have $100 (0.14%) more than I would have been without selling the call. I can sell a call again if I want.

    3) VTI is up at $150.01 or higher, and my 500 shares are therefore sold to the call buyer at $150 each. I made $2 per share plus 20c per share on the call (total of $2.20 per share aka 1.5% in TEN DAYS). With that cash, I can buy the shares again or buy anything else I want in the market. Those shares made 1.5% in ten days… perhaps you can do the math on what rate that is annually? Again, I am dumb and risky and dole out poor advice, so I surely don’t understand math.

    …it is clear that you know much more than a simple gambler such as I, so I want to know what I’m missing here. I earnestly do. In which scenario did I get pancaked? Where did my account get wiped out? These are real prices on that stock and the low end of the call selling value from today’s market. All I see is small cash gain in scenario 1, minimized my loss in 2, and sizable gain in 3. Please, wise master, do tell: Where was the huge risk being taken?

    Lordosis wrote:

    Click to expand…

    ….If that is what you call investing then I will continue saving.  My guesses and market timing will likely just make matters worse.  In down market times I will like most tighten the belt a little but otherwise market corrections are built into the 4% rule.  It is not perfect but it is better then me guessing…

    Click to expand…

    You are afraid of what you don’t understand ^^

    There is nothing wrong with that, but feel free to say “I don’t understand that” rather than dismiss something because you are unsure or afraid of it.

    Trust me, this type of basic income option (as well truly risky strategies) are exactly what mutual funds and banks are doing with billions of shares of stock right now. Covered calls are not risky or based on market timing… the investor is just exchanging slight upside for more POP (probability of profit). It is a very proven model and very easy to do. You are effectively giving someone else a lease option on your stock. Is that person being risky with speculation or advanced options? Probably, but it is of no consequence to you.

    In my example above, the only way to profit off those same shares of VTI for a traditional buy-and-holder is if VTI price goes up (and stays up), but the VTI covered call seller makes profit in two of the three scenarios… and loses less in the other since he still got the call fee. Covered call seller also still gets all dividends as long as he owns on ex-date. The covered call seller does miss out on a bit of gains in scenario 3 if the price goes way over $150 (that is the “risk”… to miss big gains), but a buy-and-holder wouldn’t have sold it on that peak anyways, and it might dip right back down. The call seller just takes his income and can restart the process whether he keeps the stock and a bit of cash… or sells the stock and gets a lot of cash. You can repeat it infinitely, especially in bear markets, where strike prices rarely hit. In bulls, the stocks will hit strike prices and you will have to sell the shares more often (scenario 3 above), but the bull market covered calls tend to pay more and you profited more.

    I think the covered calls are much easier than Tim makes them sound… all you want to do is usually a call with delta 0.1-0.4 and strike date 20-40 days away (when time decay will drop the call the fastest) for max call selling profitability, but the details are up to your comfort level and whether you care much if you lose (sell) the stocks as to choosing to do ATM or OTM calls and long or short term ones. It is a bit of an art, but it is simply not a risk (just neuters top end gain potential to get guaranteed cash and increase POP on the shares). Calls will usually be worth significantly more than the 0.14% for 10 days in my example, but VTI is a very slow fund to trade and 10 days is a short duration call (it just fit for example of how you can do calls on whatever stock or ETF you like). Call prices are based on stock volatility, time remaining, and overall market sentiment. Again, no risk and no market timing, though.

    Google covered calls… or YouTube it… or don’t. Doesn’t affect me. Just don’t knock things you don’t even comprehend. You wouldn’t go tell a speaker at a CME event that he is a fool just because you’ve never heard of the test or procedure he is lecturing on. You’d probably simply ignore him or listen and learn… but not bash or heckle, so it’s equally inappropriate to do so here. GL

    …and feel free to send a “WooooW!” message when you learn and try it and discover how this works in a month or a year or 10 or whatever.

    #205099 Reply
    Lordosis Lordosis 
    Participant
    Status: Physician
    Posts: 776
    Joined: 02/11/2019

    Transaction costs? Taxes?
    More often than not the market is up leading the but and holder to have the advantage.

    “Never let your sense of morals prevent you from doing what is right.”

    #205102 Reply
    fatlittlepig fatlittlepig 
    Participant
    Status: Physician
    Posts: 667
    Joined: 01/26/2017

    [income from stocks, ie covered calls] is investing.

    Click to expand…

    That is picking up nickels in front of this: https://www.cat.com/en_US/products/new/equipment/compactors/tandem-vibratory-rollers/1000027460.html

    Sure the roller is moving slowly, yeah your fast picking up those nickels, but only one misstep and you get run over and wiped out financially speaking.

    Click to expand…

    Please, do enlighten me. Show me how someone selling covered calls on quality ETFs or stocks they like owning gets steamrolled. I implore you.

    If I own 500 shares of VTI (total US market index ETF) and it is at $148 per share today (Apr 8th)…

    I sell a covered call for exp date April 18th at strike price of $150 for 20c per share. I instantly get $100 (20c per share x500) in my acct.

    Ten days (8 market days) later, on exp date (morning after, but that is minutia), one of three things will happen:

    1) VTI is trading same price ~148, and I keep the shares. I’m up $100 (0.14%) in ten days, . I can sell a call again if I want.

    2) VTI is down under $148, and I keep the shares (just like a buy-and-hold)… but I have $100 (0.14%) more than I would have been without selling the call. I can sell a call again if I want.

    3) VTI is up at $150.01 or higher, and my 500 shares are therefore sold to the call buyer at $150 each. I made $2 per share plus 20c per share on the call (total of $2.20 per share aka 1.5% in TEN DAYS). With that cash, I can buy the shares again or buy anything else I want in the market. Those shares made 1.5% in ten days… perhaps you can do the math on what rate that is annually? Again, I am dumb and risky and dole out poor advice, so I surely don’t understand math.

    …it is clear that you know much more than a simple gambler such as I, so I want to know what I’m missing here. I earnestly do. In which scenario did I get pancaked? Where did my account get wiped out? These are real prices on that stock and the low end of the call selling value from today’s market. All I see is small cash gain in scenario 1, minimized my loss in 2, and sizable gain in 3. Please, wise master, do tell: Where was the huge risk being taken?

    Lordosis wrote:

    Click to expand…

    ….If that is what you call investing then I will continue saving.  My guesses and market timing will likely just make matters worse.  In down market times I will like most tighten the belt a little but otherwise market corrections are built into the 4% rule.  It is not perfect but it is better then me guessing…

    Click to expand…

    You are afraid of what you don’t understand ^^

    There is nothing wrong with that, but feel free to say “I don’t understand that” rather than dismiss something because you are unsure or afraid of it.

    Trust me, this type of basic income option (as well truly risky strategies) are exactly what mutual funds and banks are doing with billions of shares of stock right now. Covered calls are not risky or based on market timing… the investor is just exchanging slight upside for more POP (probability of profit). It is a very proven model and very easy to do. In my example above, the only way to profit off those same shares of VTI for a buy-and-holder is if price goes up (and stays up), but the VTI call seller makes profit in two of the three scenarios… and loses less in the other since he still got the call fee. The covered call seller does miss out on a bit of gains in scenario 3 if the price goes way over $150 (that is the “risk”… to miss big gains), but a buy-and-holder wouldn’t have sold it anyways, and it might dip right back down. The call seller just takes his income and can restart the process whether he keeps the stock and a bit of cash… or sells the stock and gets a lot of cash. You can repeat it infinitely, especially in bear markets. In bulls, the stocks will hit strike prices and you will have to sell the shares more often (scenario 3 above), but the bull market covered calls tend to pay more and you profited more.

    I think the covered calls are much easier than Tim makes them sound… all you want to do is usually a call with delta 0.1-0.4 and strike date 20-40 days away (when time decay will drop the call the fastest) for max call selling profitability, but the details are up to your comfort level and whether you care much if you lose (sell) the stocks as to choosing to do ATM or OTM calls and long or short term ones. It is a bit of an art, but it is simply not a risk (just neuters top end gain potential to get guaranteed cash and increase POP on the shares). Calls will usually be worth significantly more than the 0.14% for 10 days in my example, but VTI is a very slow fund to trade and 10 days is a short duration call (it just fit for example of how you can do calls on whatever stock or ETF you like). Call prices are based on stock volatility, time remaining, and overall market sentiment. Again, no risk and no market timing, though.

    Google covered calls… or don’t. Doesn’t affect me. Just don’t knock things you don’t even comprehend. You wouldn’t go tell a speaker at a CME event that he is a fool just because you’ve never heard of the test or procedure he is lecturing on. You’d probably simply ignore him or listen and learn… but not bash or heckle, so it’s equally inappropriate to do so here. GL

    …and feel free to send a “WooooW!” message when you learn and try it and discover how this works in a month or a year or 10 or whatever.

    Click to expand…

    Covered calls aren’t a great strategy b/c u put a ceiling on your gains.

    #205103 Reply
    Avatar fasteddie911 
    Participant
    Status: Physician
    Posts: 281
    Joined: 05/31/2016

    3% real. 90/10 portfolio.

    #205117 Reply
    Liked by Lordosis
    Avatar Tim 
    Participant
    Status: Accountant
    Posts: 2075
    Joined: 09/18/2018

    “I think the covered calls are much easier than Tim makes them sound… all you want to do is usually a call with delta 0.1-0.4 and strike date 20-40 days away (when time decay will drop the call the fastest) for max call selling profitability, but the details are up to your comfort level and whether you care much if you lose (sell) the stocks as to choosing to do ATM or OTM calls and long or short term ones. It is a bit of an art, but it is simply not a risk (just neuters top end gain potential to get guaranteed cash and increase POP on the shares).”

    What you call art, I call mathematics and luck. Covered calls ACTUALLY decrease risk of loss. It is a more conservative strategy than just holding the investment. It is guaranteed insurance of a small gain on the call and neutral on the stock in exchange for limiting future gains. That’s the basics. Safe (you make money on the call guaranteed)?
    http://www.theoptionsguide.com/the-greeks.aspx
    The math is defined, purely numbers. Even Fidelity has a tool that boils it down to a rollover strategy for each security based on everyone of the variables you mentioned. You can see the projected return. The luck part is my term for the actual price at expiration. That is still unknown. The math is solid, of course the current bid/ask spread you see might not fill. Options markets are much thinner than the underlying equity.
    Just because it is “safer than just holding the stock” doesn’t make it “good”. Future price appreciation has value. My point is “understand what you own”. I can sell calls all the way to December 2021. If you don’t understand the numbers, you don’t understand the financial instrument. You get paid for guaranteeing you will sell at a price. Was it a fair price or did you leave money on the table? Blindly selling covered calls on your holdings will negatively impact your returns. Making money off of volatility is the underlying premise. That in itself is a risky strategy. The fact that you own the stock secures that risk. A covered call investment strategy is aimed at income generation. That is completely different than a diversified index portfolio AA approach.

    #205121 Reply
    Zaphod Zaphod 
    Participant
    Status: Physician, Small Business Owner
    Posts: 5627
    Joined: 01/12/2016

    Here is a chart of current valuation metrics relative to their own historical means:

    Here is a graphical depiction of the inverse correlation between 10-year returns and starting valuations. The graph is inverted. For example, the 10-year nominal return following 2000 is negative:

    More details available here: https://www.advisorperspectives.com/dshort/updates/2019/04/02/market-remains-overvalued

    Click to expand…

    Have you heard the argument that share buybacks, decreased outstanding shares and inflated eps from such has artificially raised CAPE (some, ofc its still very high). Thats a new one on me, interesting.

    #205131 Reply
    Molar Mechanic Molar Mechanic 
    Participant
    Status: Dentist, Small Business Owner
    Posts: 364
    Joined: 10/29/2017
    Disability Insurance

    I don’t project aside from what the online calculators default to…it just doesn’t matter.  I just spend what I’m comfortable with and save the rest.  At some future date, my future path will be far clearer than it is now and I’ll make some decisions about increasing spending or decreasing earning.  If you aren’t planning imminent retirement and are saving well, just go on autopilot.  I’m also under 10% bonds, and those are only due to a shared defined benefit plan that is 60/40.

    When the time does come, I’ll model out what the minimum expenses I’ll tolerate and what my goal expenses are, and make sure I have enough.

    The future doesn’t care about your projections.

    #205133 Reply
    Zaphod Zaphod 
    Participant
    Status: Physician, Small Business Owner
    Posts: 5627
    Joined: 01/12/2016

    Covered calls can be great. You dont have to limit your gains either though it can happen. You can either close the position (often if its been some time it will still be less than sold), buy the stock near the strike or get calls at a higher strike.

    Its a conservative strategy. I prefer to use indexes as they can be more liquid and unlike stocks you dont have buyouts and such with risks of a 50% move out of the blue. Not risk free of course, but over a longer time frame they can be good. Biggest drawback is the time component of having to be more active.

    #205135 Reply
    Lordosis Lordosis 
    Participant
    Status: Physician
    Posts: 776
    Joined: 02/11/2019

    @lordosis,
    You forgot one or two factors.
    Great job in defining your risk capacity and risk tolerance.
    1) About that income capability. You didn’t mention a biggie, the DI insurance, life insurance, malpractice and umbrella policies.
    Those let you tolerate a higher AA.
    2) My only question is are you taking more than you need? Not really convinced you have noodled that one around enough. With the time horizon, you haven’t needed to address that completely.

    Click to expand…

    Insurance is covered.

    I do not understand your second question?  Taking more then I need for what?

    “Never let your sense of morals prevent you from doing what is right.”

    #205173 Reply

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