1. GEK2507 1 Frederick H. Willeboordse phyfhw@nus.edu.sg Compound & Prosper!

2. GEK2507 2 Financial Markets Lecture 10

3. GEK2507 3 Asset classes Historical performance Be critical of numbers, know what they mean. Be aware! The data used in this lecture have not been verified nor are they complete. They are used for illustrative purposes only! Today’s Lecture

4. GEK2507 4 Excel Basics – SORT Sorting can be very useful. E.g. if you have a membership list you may want to sort it alphabetically. The sort function can be accessed from the ‘Data’ menu. Select the Cells you’d like to sort. Choose ‘Sort’ from the ‘Data’ menu, select your sorting criteria from the box that pops up and press ‘OK’.

5. GEK2507 5 While we have already talked about these, it is important to realize the qualitative difference between them. Cash and Money Markets Bonds Real Estate Stocks The major asset classes are: There are of course other asset classes … some better than others Cards (Pokemon, Baseball) Collections (Coins, Stamps) Art (Paintings, Sculptures) Asset Classes

6. GEK2507 6 Asset classes like cards and collections may be excellent but we shall focus here on the ‘financial’ asset classes of stocks, bonds and money markets plus real estate. The main reasons being that theses classes are by far the largest and most liquid and therefore suitable for all investors. Whether or not an asset class is major, its performance will always be benchmarked. Perhaps the most important reference benchmark is inflation. Asset Classes

7. GEK2507 7 We already had a look at inflation in the lecture on the time value of money. If we have a 1000 dollars today, we can ask two (equivalent) questions: How many dollars do we need in 25 years to buy the same goods that we can buy now for the 1000 dollars? What are the 1000 dollars worth in 25 years if we keep them stored in our mattress? Asset Classes & Inflation

8. GEK2507 8 =FV(D6,H6,0,-D5) =PV(D6,H6,0,-D5) That’s a big amount! In order to get a bit a better idea about the effect of inflation, it is useful to plot a graph. Inflation Revisited

9. GEK2507 9 Inflation Revisited

10. GEK2507 10 Let’s see what this would mean for a bit a higher rate. Say 24%, the same rate most credit card companies charge you for overdue amounts. Asset Classes & Inflation

11. GEK2507 11 Credit cards are a baaaaad idea (if you don’t pay at once)!!!! $0.54 $1,861,054 Yes!!! These are the correct numbers! Your $1000 will be worth 54 cents ! Credit Cards Inflation Revisited

12. GEK2507 12 It is also illustrative to see what a change in interest rates means Inflation Revisited

13. GEK2507 13 So whatever we do, we need to take inflation into account when comparing the performance of asset classes. Actually, there is no reason to be sad. As such, moderate inflation is not necessarily a bad thing as long as your income growth and/or return on investment can outpace it sufficiently. Asset Classes & Inflation

14. GEK2507 14 As mentioned in the lecture on values, risk is an essential issue when evaluating the merits of an investment. Money Market Bonds Stocks Extremely low Very low Medium to Very High Asset ClassRisk Hopefully, this will be reflected in the historical returns. Asset Classes & Risk

15. GEK2507 15 Let us have a look at Siegel’s data again. Stocks Bonds Gold Dollar Historical Data

16. GEK2507 16 The consumer price index (CPI) is a good proxy for inflation and therefore a closely watched number. A lot of information (for the US) can be found at the website of the bureau of labour: http://stats.bls.gov/cpi/home.htmhttp://stats.bls.gov/cpi/home.htm A good page for some useful statistics is: http://146.142.4.24/cgi-bin/surveymost?cuhttp://146.142.4.24/cgi-bin/surveymost?cu. Lets get the average data for most of the past century.average data for most of the past century Historical Data - CPI

17. GEK2507 17 How does one get these data into Excel? Fortunately, Excel can open html files. But in older versions, everything ends up in one column. Historical Data - CPI

18. GEK2507 18 Use the ‘Text to Columns’ feature in the Data menu, throw out the monthly data and calculate the percentages. =(B3-B2)/B2 That’s better! Historical Data - CPI

19. GEK2507 19 Let us compare: =AVERAGE(C3:C88) A big difference! =POWER((B88/B2),1/(A88-A2))-1 =FV($G$4,A88-$A$2,0,-$B$2) =FV($G$3,A88-$A$2,0,-$B$2) Actual Data Compounded with the correct average inflation Rate Compounded with a simple average Historical Data - CPI

20. GEK2507 20 What is historical? Which period should one look at? Average Inflation? High Inflation? Low Inflation? Actual CPI Compounded CPI, when compounding with the correct average inflation rate Historical Data - CPI

21. GEK2507 21 The Dow Jones is a good reference for the overall performance of the stock market. Dow Jones has a nice website with many data: http://averages.dowjones.com/ As does Standard and Poor’s: http://www.spglobal.com/ Historical Data – Dow Jones

22. GEK2507 22 The difference between the two periods is very big. These calculations do not take dividends into account. Repeat: Do not blindly trust averages. Historical Data – Dow Jones

23. GEK2507 23 Let us see what happens if we take dividend into account Dividend has a significant impact. And of course we should not use the average but the yearly values for the dividend. =D7*(1+C6+$G$16) Historical Data – Dow Jones

24. GEK2507 24 Quite a lot of information on bonds can be found at: http://www.federalreserve.gov/rnd.htm Historical Data – Bonds

25. GEK2507 25 Yield on the 10 year treasury note Historical Data – Bonds

26. GEK2507 26 It is illustrative to compare the relative changes: Historical Data – Compared

27. GEK2507 27.. And the what that means for 1000 dollars: Are stocks really better than bonds? Historical Data – Compared

28. GEK2507 28 Once again, the conclusion one can draw from these data depends entirely on one’s perspective. The numbers alone mean little. The interpretation of the numbers must be justified by sound arguments. Understanding is the ONLY way even if it means going through some math! Solely memorizing convenient Excel functions is pointless! Historical Data – Compared

29. GEK2507 29 The comparison of data is essential in understanding business data. Know what the numbers mean. The average, e.g., may not be what you think. The three main asset classes have rather different historical performances. Key Points of the Day