The Investment Scientist

Archive for December 2008

Boston Globe: “Harvard’s endowment plunges $8 billion

WSJ: “Harvard hit by loss as crisis spreads to college

Harvard Crimson: “Yale losses a quarter of its endowment

Edward Eptein in The Huffington Post argues in “How much has Harvard really lost?” that Harvard endowment loss could be a lot higher than disclosed.

Check out how Harvard and Yale endowments performed prior to this fiscal year here. Note their fiscal year ends in June 30th.

“Successful investing,” in the words of British economist John Maynard Keynes, “is anticipating the anticipations of others.” In this vein, a market hits bottom when most people think that most other people think it has hit bottom. Only then, most people start to buy stocks, creating a self-fulfilling prophecy. If most people think the market should hit bottom, but they also think that most other people don’t think that, they won’t buy stocks and the market will continue to drop. So, predicting when a market will hit bottom is a mind game on a grand scale. If there are people who are good at that, I am certainly not one of them.

Prescience not needed, discipline required

Now let me ride a time machine to January 1929. Let’s say I committed to invest $100 every month in the S&P 500 index. I did not have the prescience to know that the market would crash in October and the Great Depression would follow. But if I had the discipline to carry out that investment plan over 30 years, the table below summarizes what would have happened to my investment through the worst stock market period in history.

Year from Jan 1929 Total invested Portfolio value Total dividend received Total gain (loss) Dividend contribution to the gain
1st year 1,300 1,115 23 (161)
2nd year 2,500 1,779 98 (623)
3rd year 3,700 1,737 230 (1,734)
4th year 4,900 2,771 415 (1,714)
5th year 6,100 5,547 629 76 100%
10th year 12,100 12,835 3,024 3,759 80.4%
20th year 24,100 30,786 13,683 20,369 67.2%
30th year 36,100 135,992 47,960 147,852 32.4%

Data source: Professor Robert Shiller’s website

The total gain from my investment plan is the portfolio value plus total dividends received minus total money invested. As you can see, though I suffered losses in the first four years, I had a small gain in the fifth year (January 1934)! This result is not bad, considering that between1929 and 1934 were the worst years for the stock market (an 89% drop) in history.

For the first 10 years of my hypothetical investment, dividends accounted for 80.4% of the total investment gain. This means that if I had invested in high dividend stocks, I would have done even better. (Also see my newsletter article, “Dividends to the rescue in a Great Depression“.)

Here is the take-home lesson from my time travel experiment: to recover from the market crash and to survive a recession, however deep, you don’t need prophecy, just discipline and patience.

The author is president of MZ Capital, a RIA serving DC/MD/VA. Get his monthly newsletter in your mailbox or get to the directory of his past articles.

I wrote this article in early December 2008. Amazingly, it is one of the least read in my blog. Hadwealth-preservation someone read it and followed it, he would have earned 10% return so far in 2009.

– Michael Zhuang 3/10/2009

At the moment of writing this, SPY, the exchange traded fund (ETF) for the S&P 500 index, is trading at $85.95 and the near at-the-money call option (with strike 86 and only eight days until expiration) is trading at $3.45! (A call option is the right to buy the underlying stock at the strike price. At-the-money means the option strike price is equal to the price of the underlying stock.)

The at-the-money call premium is a full 4% of the underlying index price! Historically, that number has been in the 1% to 2% range.

What does 4% premium imply?

Read the rest of this entry »


Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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