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Principles of finance a la shmoop historical rates of return....

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alright well someday in a deserted parking lot with nothing around you [Car alone in a parking lot]

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drive slowly for fifty feet using only your rearview mirrors to guide you our

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lawyers look like they're about to pass out now that we've asked you to do this [Lawyer collapses]

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so maybe just think about doing it anyway you drive really or virtually in

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the parking lot looking in the rearview mirror you get a decent sense of what's

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behind you but it's really hard to tell what's ahead and if your parking lot is [Car driving and man is struck by car]

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like most you'll see a line of concrete tire hubs or bollards in neat little

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rows behind you and you have great comfort driving in parallel seeing them

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tick off behind you one two three yeah until you hit a tree when you pull your [Man in car and airbag deflates]

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head out from the airbag deployment well you'll notice that you've long since

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left the parking lot and run into trouble that's kind of how the history

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of investing works you think you're in a parking lot looking at old data in the

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history of how companies did in this era and that era until you realize you're [A packed car parking lot]

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not in a parking lot and yeah bad things happen and a good way to get killed is

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to drive fast around that parking lot believing that the parking lot continues [Car driving fast in a deserted parking lot]

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forever all right for clarity our little allegorical lots can be bull markets

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bear markets, markets of low liquidity, markets of high liquidity Asian Tiger

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driven markets tech bubbles and any other vibe which lulls investors into [Investor being hypnotized]

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thinking that this parking lot is a steady-state infinite thing and will go

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on you know forever and ever and ever and there's no trees so remember all of

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the above when you think about the notion of historical returns there's a

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great little company called Ibbotson that tracks all this data take a gander

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check the numbers and a few things you will note large cap companies are those

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valued above say twenty billion dollars grow slower than small cap

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companies, does this make sense? large cap companies have already found

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their market their markets maturing and they simply can't grow at the 100%

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a year rate that they were able to grow when they were young pups like [Smartphones appear on a table]

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how many cell phones can one person own anyway by the same token

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large cap companies don't die as often or as quickly as small ones they do die [Large cap company headstones]

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r.i.p Nokia Yahoo Toys R Us Sears and who knows someday Google and or Amazon

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note that at one point Nokia was the largest market cap company in the world

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and then through overly conservative management who was out of touch with a [Person with a briefcase of nokia appears]

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rapidly changing marketplace died a painful slow death nearly taking their

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entire country down with them yeah thank you Apple...

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well does it make sense that large cap companies are less volatile or have less

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data than small ones yes but maybe not for all the reasons you'd guess large

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caps are simply big fat ships that are hard to turn but they're pretty stable [Large cap company ship in the ocean]

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in storms so that's an obvious one but large caps also usually have

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2excess capital" that is they don't generally carry a ton of debt if

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any and in a volatile market a company with no debt and maybe lots of net cash

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will generally bounce a lot less than a company leveraged five times debt to [5X EBITDA boat appears]

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cash flow and partly because of the strong balance sheets well large caps

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often pay a dividend which helps stabilize them as well small caps just

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want growth so they keep their dividend and reinvest in product and stuff like

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that well another force here is the

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international market small caps tend to be domestically based not necessarily

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just in the US but in the country in which they were started like Alibaba [Alibaba.com by Chinese map appears]

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was a small cap at one point in China large caps have usually had time to be

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globally exposed so that when one economy is falling off the shelf and

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another one's usually doing okay and by the time that Savior economy is starting

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to die in the seven-year cycle the initially dying economy is recovering [7 year boom/bust cycle graph appears]

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it's kind of a you know portfolio of company progress well the overall effect

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is to mollify beta or volatility in the company's results smooth sailing kind of

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boringly upward which is just fine for most investors alright well so that's a [Boat sailing by in the ocean]

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stock market you don't want to drive only looking in the rearview mirror you

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got to think about where you're going yeah GPS that's the key now think about

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stocks versus bonds as it relates to historical rates of return if you're

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really just not frisky then bonds are probably going to be your preferred [Man discussing bonds]

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investment meal... you have a bunch of choices think

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corporates like junk bonds and standard corporate bonds

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you also have muni bonds if you're wealthy anyway and you pay a lot of

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taxes and immunities you know that are tax free and then there's government bonds

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for the really nervous Nellie's out there so that's some risk really not

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much risk and pretty much no risk that's how they sort of categorized there [No risk, some risk and not much risk bonds appear]

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Is no risk low volatility good well usually no at least not over time

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if small caps compound as mid to high-teens

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something like that 12-15 percent maybe more and large caps compound in the 10

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percent zone well then you can think of corporate bonds as compounding maybe in

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the mid single zone like 4-5 percent with muni bonds and government

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paper in the mid to low single zones like 1-4 percent

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something like that and over time compounding at such a low rate is

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actually crushing to your overall wealth if you're giving up four points of

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compounding per year remember that rule of 72 thing it'll tell you that in [Rule of 72 appears]

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eighteen years because 72 divided by four is eighteen you'll have half of the

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nest egg that you would have had have you been willing to suffer the potential [Nest egg cracks and cash appears]

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volatility of the next up level of risk and yes this is a massive over

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generalization but it's just for structural illustration of how you want

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to think about risk and reward here yes you could have bought a given large cap

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when it was a twenty billion in valuation only to see it 10 years later

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be worth a trillion dollars and yes Apple we're looking at you but those are [Apple headquarters appears]

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rare and they don't reflect the category delineation we're trying to illustrate

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here we're talking about the overall markets of stocks and bonds

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why are bond such a "dangerous" investment to make yeah you remember

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inflation well that's right usually bonds after-tax for individual investors [Balloon inflates]

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well they don't even beat inflation so over time your dollars buy less and less

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for you so that's a problem and here's a chart of the S&P 500 through 2018 and

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here's path A, B and C and yeah we have no crystal balls how high or low can you [Person covering hand over crystal ball]

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go..... [Man dancing]

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