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Author: BoxCarRidder4 Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 74759  
Subject: Re: Map to the Future Date: 5/31/2007 5:24 PM
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2000.....$4000 borrowed
20001 owe now $8000 plus $280 interest
2002......owe now $12000 plus $580 interest....
2003 owe now $16,000 plus interest...
2004 owe $17K
2006 and on and on......

and that assumes they will allow you to just add on the interest to the loan.....rather than pay it yearly....


This assumes that you are compounding your interest in a negative direction, but the interest does not compound, it is paid yearly.


Meanwhile, dividends at 3% of GDP, divided by market capitalization equal to 120% of GDP, translate into an average dividend yield of 2.5%.

Capital growth at 1.6%, compounded by Dividend Yields of 2.5%, suggests long run index fund equity returns of 4.1%.

This is a far cry from the 7% returns of yesteryear. Slower population growth slows GDP. Higher Market Cap to GDP Ratios reduce Dividend Yields. Even with some favorable caveats, it's hard to make a case for long run returns much above four percent.

The argument on behalf of personal accounts is a reasonably sunny one if we believe the stock market will produce real ROI's of 6.5% in the future. It's much less sunny if we take the prudent investor view I've just outlined and assume real ROI's of around 4 percent."

So if we run your numbers at 4% real returns per year, vs the 7.5% rate on the debt, we get different answers.


You are using purely domestic numbers, which would be more meaningfull to someone who wishes to only invest in the S&P 500. In the Vanguard 2050 Target Retirement, a 70% total U.S. stock market allocation is used. Only a foolish (not Foolish) person constructs a purely domestic portfolio today.


Returns on stock correlate to the P/E at the time of purchase
http://www.investmentu.com/IUEL/2005/20050509.html
Ed divided the 20-year return results into 10 groups, based on returns. And as the table here shows, the lowest returns for the next 20 years came when stocks were expensive - when the P/E averaged 19 at the beginning of the period. And the best returns came when stocks were the cheapest. Take a look at chart below:
At P/E of 19 returns were in the 5% range
At P/E of 11, returns were in the 10-12% range....


I think that is a very weak correlation to base any analysis upon. Yes there is an average line, but the points are all over the place, including almost 1/3 of years when P/E was below 10 the returns were 6% or lower. You are using an average to apply where it should not be used. Obviously buying cheap and selling high will earn great results most of the time, but the graphical display shows there were many times when this was not true and you cannot depend upon the correlation to provide accurate expectations.

-Will

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