7% Return Profile and Beating the Market

For various reasons this has been under attack lately.

“Given all the changes in the economy how are we ever going to get 7% returns!”

Well the good news is anyone (not everyone) can get 7%+ returns over the long-run assuming that you are able to control your emotions. As mentioned previously, it is psychologically more difficult to handle a 50% downtick, this is also why the short end of a long-short book is much more difficult to control. Notably, the largest reason why the 7% return profile is under attack is the interest rate in your bank account which is roughly 1% if you stash it in a money market account. Get everything excluding your emergency fund out of there.

“7% is impossible”

Bonds: Starting with the more obvious lets look at long-term bonds, how about the Barclays Capital Long-term bonds. The total return has been 45% since June of 2007 excluding dividends this alone represents a 6% CAGR, add in a couple percentage points and you’re already there.

Many naysayers are going to look at the numbers and say “but this is just one index” or “this is a short time period” so with that said here is a list of bonds you can buy, simply pick what you like. (iShares Barclays 20+ Yr Treas.Bond, Vanguard Long-Term Bond Index, iShares Barclays MBS ETF, Vanguard Extended Duration ETF, Vanguard Long-Term Bond Index, iShares IBoxx $ Invest Grade Corp). Effectively find a large long-term bond index, low fees and continue to invest monthly and you’re good to go.

Stocks: If for some reason, you believe stocks will continue to outperform bonds over the long-run (as it has over many decades) simply buy SPY. It really is that simple, yields 2% and should warrant a long-term 5-10% growth profile with a higher standard deviation.

That is all. Stop reading. Do not pass this line until you are 100% committed to the idea that you’re doing nothing but losing money sitting on over 2 months in living expenses.

“Above Market Rate Returns”

Alpha: Lets move onto beating the market or “alpha”. Of course, more naysayers will point to “average hedge fund return” in a particular time period and say you can never beat the market. Ignore them. By saying you cannot find a good security effectively means you “cannot find a good business to invest in”. Considering that the entire business of Private Equity is to lever up and fix a company, you would then need to say that Private Equity is a bad business and should not be profitable long-term… KKR, TPG and the like have held up just fine. There are always good businesses to buy, ie: invest in. Working for a start up, is no different than putting a large sum of cash into a single company, in fact, it increases your risk and reward profile as your job is also liable if the company goes under.

Know a Space: With that said, the best way to find a strong business to invest in is no different than any other part of life, spend hundreds of hours researching a specific space. Know it well. Diligently go through every single SEC filing, read hundreds of transcripts, read hundreds of research reports, be able to understand the dynamics to the T on everything in one space and start hunting. If you’re unwilling to spend many grueling hours learning a niche space, or don’t have the time, go back to the top of this page and invest all of your capital into baskets of long-term bonds and stocks with no fees attached to them.

Reap Rewards: To hammer in the point that above market rate returns can be seen, just pull up Berkshire’s stock relative to the market… here it is.

The Company’s portfolio has consisted of many securities over time (Sees Candy, Wells Fargo, IBM and others), and the relative return is quite impressive. Back of the envelope if you look at the beginning of Berkshire, it grew 2x the market rate… a CAGR that exceeds the S&P by 2x is beyond phenomenal over roughly 30 years.

Conclusion: If you have any doubt that you’ll be unable to watch your investment decrease by 60-70% in a single year, you should stick to the long-only camp. In addition, we believe it is possible for anyone to learn one space and get smart to achieve above market rate returns. Notably, the number of people willing and able to put in the work is likely well under 1%, so buy a basket and get your money out of that checking account.