Statistics do lie - a glitch with time doesn't save nine

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This was published 11 years ago

Statistics do lie - a glitch with time doesn't save nine

By Marcus Padley

WE USED to have an economist at UBS Phillips & Drew in London who retired in the mid-1980s.

He stood up for his last morning meeting and told the assembled advisers that he had asked his wife the night before what he could possibly tell us today that would be his legacy, that we would remember him by for the rest of our lives.

Illustration: Jim Pavlidis.

Illustration: Jim Pavlidis.

''You're an economist, darling,'' his wife had told him. ''You've been giving them useless statistics for 50 years, give them one they can use.''

So he did. He told us that he had spent the night opening every Excel spreadsheet he had ever had, taken every number in every spreadsheet he had ever had, put them in one spreadsheet and averaged them.

The result was that he had worked out the ''the average statistic in the financial space over 50 years''. With much satisfaction, he declared it to us: ''It is 9 per cent!''

The average interest rate is ''nine'', he said. The average return on investment is ''nine'', he said. The average growth in house prices is ''nine'', he said and although it seems irrelevant, armed with this piece of information a broker could now answer almost any question ever asked.

''What's the return on capital employed of the Brazilian subsidiary of ICI?'' for instance. Well, there's a very good chance it's ''nine'', he said.

Tremendous stuff for an industry that survives on confident guesswork.

So we used to use this in the equity department, most obviously when selling the concept of investing in equities. We used to tell clients that the average annual compound return from the stockmarket was - why not? - 9 per cent, plus dividends and compounding, that you would double your money every six years and triple it every 10.

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Longer term, if you ignored dividends, took $1 on September 30, 1937, 75 years ago, invested and compounded it at 9 per cent a year for 75 years, then as of September 30, 2012, it is worth $903. Cripes.

Invested in the All Ords Index then, $10,000 in 1937 would now be worth $9.03 million before dividends. Wow, let's all buy equities and hold on forever. How simple the investment game is. Invest for the long term. No brains required. Fantastic.

Except for one little problem.

Tempting as it is to plough all our money into equities forever and remove brains, there is a question someone has to answer. If $1 compounded at the average return of 9 per cent a year for 75 years turns into $903, then why has $1 invested in the All Ords on June 30 1937 actually only turned into $66.37.

What! It's supposed to be worth $903 - $66.37 is only a 13th of $903. Are you telling me the average return isn't 9 per cent a year after all?

Well, yes. Work it back and the actual compound return the All Ords has delivered since 1937 is just 5.7532 per cent, not 9 per cent, and at that rate you don't double your money every six years and triple it every 10, you double it every 13 years and triple it every 20. And really it depends when you invest.

That average takes into account a debt boom, arguably a moment in history never to be repeated.

During the debt boom, the All Ords grew at 11.6812 per cent for 33 years from 1974 to 2007. Before that, the market grew at 2.6933 per cent for 37 years (less than inflation). So what do we use, 5.7532 per cent, 11.6812 per cent, 2.6933 per cent?

Bottom line, you can pick whichever one you want to make your point but the truth is there is nothing in history, in past averages, that you can rely on. It's all bullshit. The past is not your future.

The next 75 years is going to be different to the last and the next one year, five years, 10 years or 37 years could return anything. Tell that to the next person that quotes you an average return.

Using the past as the future, especially in this market, is marketing rubbish. What you experience between now and when you need your money is going to be something unique. You can pray for a bull market, but don't ''expect'' it based on the past. Best you prepare yourself for something unknown.

Marcus Padley is a stockbroker with Patersons Securities and the author of sharemarket newsletter Marcus Today. For a free trial, go to marcustoday.com.au. His views do not necessarily reflect those of Patersons.

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