Asset Classes

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Asset Classes Financial Markets

• Lecture 11
• This lecture is part of Chapter 5 Becoming a
  Millionaire

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Todays Lecture

• 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!
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Asset Classes
While we have already talked about these, it is
important to realize the qualitative difference
between them.
The major asset classes are

• Cash and Money Markets
• Bonds
• Real Estate
• Stocks

There are of course other asset classes some
better than others

• Cards (Pokemon, Baseball)
• Collections (Coins, Stamps)
• Art (Paintings, Sculptures)

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Asset Classes
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.
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Asset Classes Inflation

• 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?

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Inflation revisited
FV(D6,H6,0,-D5)
PV(D6,H6,0,-D5)
Thats a big amount! In order to get a bit a
better idea about the effect of inflation, it is
useful to plot a graph.
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Inflation revisited
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Asset Classes Inflation
Lets 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.
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Inflation revisited
Credit cards are a baaaaad idea (if you dont pay
at once)!!!!
Credit Cards
Yes!!! These are the correct numbers! Your 1000
will be worth 54 cents!
0.54
1,861,054
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Inflation revisited
It is also illustrative to see what a change in
interest rates means
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Asset Classes Inflation
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.
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Asset Classes Risk
As mentioned in the lecture on values, risk is an
essential issue when evaluating the merits of an
investment.
Asset Class
Risk
Money Market Bonds Stocks
Extremely low Very low Medium to High
Hopefully, this will be reflected in the
historical returns.
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Historical Data
Let us have a look at Siegels data again.
Stocks
Bonds
Gold
Dollar
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Historical Data - CPI
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.htm A good page
for some useful statistics is http//146.142.4.2
4/cgi-bin/surveymost?cu . Lets get the average
data for most of the past century.
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Historical Data - CPI
How does one get these data into Excel?
Fortunately, Excel can open html files. But
everything ends up in one column.
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Historical Data - CPI
Use the Text to Columns feature in the Data
menu, throw out the monthly data and calculate
the percentages.
(B3-B2)/B2
Thats better!
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Historical Data - CPI
Let us compare
Compounded with a simple average
Compounded with the correct average inflation Rate
Actual Data
AVERAGE(C3C88)
POWER((B88/B2),1/(A88-A2))-1
FV(G4,A88-A2,0,-B2)
A big difference!
FV(G3,A88-A2,0,-B2)
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Historical Data - CPI
What is historical? Which period should one look
at?
CPI, when compounding with the correct average
inflation rate
Actual CPI
Compounded
Average Inflation?
High Inflation?
Low Inflation?
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Historical Data Dow Jones
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.dowj
ones.com/home.html As does Standard and
Poors http//www.spglobal.com/index.html
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Historical Data Dow Jones
The difference between the two periods is very
big.
Repeat Do not blindly trust averages.
These calculations do not take dividends into
account.
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Historical Data Dow Jones
Let us see what happens if we take dividend into
account
D7(1C6G16)
Dividend has a significant impact. And of course
we should not use the average but the yearly
values for the dividend.
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Historical Data - Bonds
Quite a lot of information on bonds can be found
at http//www.federalreserve.gov/rnd.htm
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Historical Data Bonds
Yield on the 10 year treasury note
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Historical Data Comparing
It is illustrative to compare the relative
changes
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Historical Data Comparing
.. And the what that means for 1000 dollars
Are stocks really better than bonds?
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Comparison
Once again, the conclusion one can draw from
these data depends entirely on ones perspective.
The numbers alone mean little. The
interpretation of the numbers must bejustified
by sound arguments. Understanding is the ONLY
way even if itmeans going through some math!
Solelymemorizing convenient Excel functions
ispointless!
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Key Points of the Day

• 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 classeshave rather
  different historicalperformances.