We answer listeners’ questions on a variety of financial topics to close out the year.
Topics covered include:
- Estimating financial market returns in the next thirty years
- Investing in art
- Whether stocks will no longer exist
- How to start investing
- Fidelity’s new Bitcoin ETF
- How mutual funds are priced
- How to teach family members about investing
- Volatility versus drawdowns
- How to face the uncertainty of crashing stocks, rising interest rates, and numerous other economic and financial threats
- David’s four most recent investments he made in his personal portfolio
Welcome to Money For the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today’s episode, 369. It’s a year-end Q&A episode. I sent out an email to the Insiders Guide email list and asked for questions on money, investing, the economy. Really on anything. We received over 80 questions. I’ll answer about a dozen, but many of the other questions will be used in future episodes of the show because all of the questions were very good.
This is the last episode of the year. We’re taking our year-end break, we have a family wedding, we have the holidays, and so our next episode, episode 370, will be released on Wednesday, January 12th.
Valuing Investments and Expected Returns
Here’s the first question. “The Money For the Rest of Us approach to valuing most investments is cash flow, expected cash flow growth, and what investors are paying for that cash flow. Are there other formulas that are commonly used? If so, what makes this formula more compelling?”
Cash flow, cash flow growth, and what investors are paying for the cash flow are really what we use to estimate investment returns, so forecasting returns. A component of that is valuations. And so we can value assets based on cash flow, so what’s the price-to-cash-flow; we can look at investments on a price-to-earnings basis, we can look at their yield relative to historical yields, we can look at valuation on different accounting metrics, such as price-to-book.
For calculating expected returns, we use those three components because that is the underlying math of investment returns, of calculating performance. Now, sometimes we use different words for that, but at its core, it’s the income plus the capital appreciation of the asset. Your return of any asset will be a function of the income, if there is income, the rent, interest, dividends, and the second is “Did the asset go up in price? Was there appreciation?” If it’s an apartment building, rental real estate. How much net income is there each year after expenses? And when you’re ready to sell that building, were you able to sell it for more than what you paid?
I don’t know of any other way to calculate returns, or estimate expected returns, because that’s just the way the math is. As an investment advisor, we would generate performance reports for clients using those elements. So that’s how it’s done. But there are definitely other ways to actually value an asset to decide if it’s overvalued or undervalued or not. But those three components, of cash flow, cash flow growth, and what investors are paying for that cash flow now versus later are the underlying elements to get to the income and the capital appreciation, which is what performance is.
As a follow-up, there’s a question from a different listener on “Is there an accurate way to estimate asset returns over a longer period of time than ten years? Specifically, 30 years.” This listener is in his thirties and feels like that’s a more appropriate time horizon.
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