Good reads from around the Web.

A couple of weeks ago Weekend Reading featured an inspiring story about a janitor who died at 92 to leave an estate worth $8 million.

His secret? Regular saving and investment into a range of blue chip US stocks (and living until 92 to work that compound interest!)

But could a janitor achieve the same thing today?

The Philosophical Economics blog thinks not.

In a deep and nerdy-in-a-good way post that unpicks returns over the past 65 years, the author concludes that it would not be feasible for the average janitor to sock away sufficient cash to get to the $8 million mark, given today’s starting valuations and the low US minimum wage.

There are wrinkles though, so do read the whole post.

I especially liked the conclusion, which was that anyone who would become rich via the stock market needs to pray for a few crashes on the way:

If you’re an investor with a short time horizon, you should want valuations to stay high, or even better, go higher, into a bubble, so that you can get the most out of your holdings when you cash them out.  But if you’re a disciplined investor that is in this for the long term, particularly a 20-something, 30-something, or even early 40-something, with a lot of income yet to be earned, you should not want valuations to stay where they are.

You definitely should not want them to go higher, into a bubble.  Instead, you should want the opposite of a bubble, a period of depressed valuations–the lower the better.

Granted, a rapid downward move in the markets, towards valuations that are genuinely cheap, would entail the pain and regret of mark-to-market losses on present holdings.  But that pain and regret will only be short-term.

In 20 or 30 or 50 or 65 years, the paper losses, by then evaporated, will have been long since forgotten, having proven themselves to have been nothing more than opportunities to compound wealth–monthly contributions, reinvested dividends, and share buybacks–at high rates of return.

The very thing that keeps many people out of equities is what we’re banking on for our long-term returns.

As I’ve explained before, it’s why I buy in bear markets.

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Good reads from around the Web.

I really enjoyed today’s spirited column by Ken Fisher in the FT [Search result] on the doomster-ism implied by the negative bond yields we’re seeing across Europe.

Monevator started life a year before the financial crisis, and its early articles were often trying to help people understand that the case for buying shares hadn’t changed just because they’d crashed – quite the opposite – and that the elevation of gold and the likes of Zero Hedge to cult status were typical over-reactions to a severe market dislocation.

A couple of years later, and the fight had turned to making the case for developed market shares – US and European companies.

Many out there, including some readers and Monevator commentators, were convinced that everyone should sell out of supposedly sclerotic mature markets in the West because the emerging markets were going to overrun us.

(A few of these Monevator commentators seem to have forgone their previous certainty, as we may well see again in comments on this post… 🙂 )

Of course, emerging markets have underperformed since then and the US has shot the lights out.

I didn’t know that was going to happen, but I was pretty convinced the doom-and-gloom theory was bogus.

A decade ago I was having arguments with people who thought peak oil was about to cripple us (never even slightly likely in our lifetimes, even back at higher prices) and a couple of years ago The Accumulator was arguing that most investors should still have money in bonds.

He was called irresponsible and reckless or worse; bonds went on to deliver excellent returns (which was unexpected and wasn’t his point, but it goes to show…)

You usually sound like a happy-clappy idiot if you take the opposite side in these arguments.

The bear case always sounds smarter.

A balanced mind and a balanced portfolio

None of this is about being particularly clever, or being seen to be clever.

It’s just a reminder that betting on extremely bad and unusual outcomes is very rarely a winning strategy.

The flipside is true, too.

For instance, those believing dotcom valuations in 2000 were justifiable because the world had changed forever were making a similar mistake.

But to stick with the doomsters, Fisher writes:

If it’s Armageddon or total societal collapse you fear, you don’t want any securities. Not stocks. Not bonds. They’ll just be worthless paper, no use for anything except lighting fires. Gold? You can’t eat gold bars.

If you really fear the total collapse of western civilization, then invest in canned food, bottled water, armour, guns, bullets, bows, arrows, knives and a bunker. Do you need a cave? Can I sell you a rock to crawl under? A shovel to dig your moat?

Does that all sound crazy? If so, go back to question one: why buy a negative-yielding long-term bond

If you do, you’re betting on a scenario you don’t remotely believe in.

Markets move on probabilities, not possibilities. If you don’t think economic doom has a snowball’s chance, don’t invest like it is inevitable.

Put your money on what’s likeliest — the world keeps turning, advancing and growing.

The unpalatable fact for the perma-bearish is that it pays to be optimistic as an investor.

Also, the most sensible hedge to that optimism being misplaced is a diversified portfolio – not a theory that everything is rigged / about to crash  / unsustainable / different this time.

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Liquidity indicates how quickly an asset can be converted into cash. Liquidity is a desirable trait in an investment.

In general, the more liquid an asset, the lower the return it offers. Investors bid up its price because they value owning assets that can be quickly converted into cash.

Coins and banknotes are the most liquid assets. They do not pay interest and in normal times they do not appreciate in value, unless they become old and of interest to collectors.1

Selling antique coins will require a trip to a specialized dealer, a valuation, and a sale by auction or commission, all of which take time and cost money, and so reduce liquidity.

A collection of rare coins is therefore far less liquid than a holdall stuffed with dollar bills, since it is expensive to turn a coin collection into ready money.

Liquid markets

The term liquidity is also used to describe how easily assets can be traded. The markets in which those assets are traded can be described in terms of this liquidity.

The most liquid markets have a high turnover of assets and many participants, and the cost of doing business in them is lower.

To return to the example of a coin collection, even big towns will usually only have one or two coin dealers. Those dealers will only be able to trade in a limited volume of coins.

Thus the antique coin market is many times less liquid than the international currency markets, in which billions can change ownership at a keystroke. The market in government bonds is similarly extremely liquid.

With shares, the situation varies.

Millions of shares in the leading blue chip companies are bought and sold every day. In normal circumstances this market is very liquid. This means the difference between the buying and selling price of the shares (known as the bid-offer spread) is usually tiny, as market makers in large caps can do profitable business on small margins due to the sheer volume of shares being traded.

In contrast, the shares of small companies are typically traded in lower volumes. In some instances, just a few thousand shares might change ownership in a typical day. Perhaps on some days no shares are traded at all.

As a result, market makers need to charge more to cover the cost of providing a market in these small cap shares. This is reflected in a wider spread.

An investor buying a tranche of shares in a particularly illiquid small cap can easily see their capital eroded by 5% or more in switching from cash to such shares because of this spread. The small cap market is far less liquid than that of large cap shares.

Prices are usually more volatile in less liquid markets, as a small number of participants can have a great influence on the price.

Academic research has pointed to an illiquidity premium for shares. This relationship suggests that owners of less liquid shares will earn a higher return than more liquid ones, as investors demand a higher return for not being able to use their rarely-traded small cap shares as a costless ATM.

A six month trade with a £5,000 spread

Assets can be very widely held but still not be very liquid.

Most people in the UK own their home, but residential property is not an especially liquid market. Relatively few homes change hands each year, buyers and sellers must pay all kinds of fees, and it can take months for a house to change hands.

When house prices fall and nobody wants or can afford to move, turnover may grind to a near-halt. At such times the market has become illiquid.

Master more financial terms with the Monevator glossary.

1. In deflationary times, cash does increase in value in real terms, because prices are falling and so your cash buys you more each year. [↩]