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In the summer of 1978 a landmark study was published in the Journal of Personality and Social Psychology. It is the sort of thing you can imagine began as a joke, while a trio of academics from Massachusetts and Northwestern universities shared a monster doobie at a conference.
Guys! Wouldn’t it be, like, so cool if we could show that victims of horrendous accidents were just as happy as the winners of shitloads of money. Hilarious, man — let’s do it. Now pass that bad boy over here.
Philip Brickman, Dan Coates and Ronnie Janoff-Bulman interviewed 22 major lottery winners, 29 paraplegics and quadriplegics, and 22 randoms. They were asked to rate the amount of pleasure they received from eating, watching TV, chatting with friends and so on.
And lo and behold, the people who had just amassed a fortune were no happier on average than the control group. They also derived the same joy from everyday activities as the recently paralysed.
It seems that humans suffer from what psychologists now call hedonic adaptation. This takes two forms. We quickly contrast experiences, hence the paper notes that the extreme joy of winning “lessens the impact of ordinary pleasures’‘.
Meanwhile, “habituation” reduces the value of new pleasures. We soon become used to them. “Even the most positive events will cease to have an impact as they are absorbed into the new baseline against which further events are judged”.
This just happened to me. In January I set my portfolio a target of reaching £500,000 by the midpoint of the year — a modest 6 per cent return. But my joy in achieving this goal a month or so early barely lasted an hour.
Just as Roman Abramovich woke at sea one day on his 162-metre Eclipse and knew that only adding the 140-metre Solaris to his fleet would make him happy — his other four are superyachts, not megayachts, duh — a million pounds has become my new target.
Of course, zero may come first. But six noughts in a row with a one in front is definitely not impossible. My aim is to reach £1mn by the time I turn 60 in 2032. That is an annual return of 9 per cent.
I also like this goal because it aligns with the famous “Rule of 72” which all investors should know. It is a simple hack you can wheel out at dinner parties if someone wants to know the years or annual return needed to double their money.
In the case of my portfolio, I want it to double in eight years. So 72 ÷ 8 gives a 9 per cent annual return. Or if you reckon 6 per cent is more realistic, then it will take me 12 years (72 ÷ 6). Funky, eh?
The Rule of 72 works for anything that grows at a compound rate, such as population size or gross domestic product. For example an economy growing at 2 per cent per year will be twice as big in 36 years (72 ÷ 2).
It is also useful when costs are expressed as a percentage. Buyers of investment funds should routinely divide 72 by the annual fee charged by their manager in order see how fast half their capital will vanish (other things being equal). Makes you question expensive active funds, I can tell you.
Anyway, back to Project One Million. Now the destination and timeframe are set, how to get there? What assets should I own? Almost a year ago I wrote that I wanted to take more investment risk in my portfolio. But how much is needed to make 9 per cent per year?
The usual approach when trying to answer these questions is based on modern portfolio theory. We must compare the expected returns of asset classes to their volatilities, then maximise the former relative to the latter.
I devoted a whole column to this topic on March 31 last year. Suffice it to say that because expected returns reference past performance, the fact that most equity markets have had a bumper run means that most forecasts are low these days.
Indeed, having just read the latest investment outlooks from the major banks and asset managers, the only major stock market offering anything close to a 9 per cent expected return is China’s.
Which I already own via a 32 per cent weighting in my MSCI Emerging Market Asia fund. Should I buy more? Everyone hates Chinese companies at the moment, which is usually enough of a reason for me to buy.
It’s certainly worth a column in the coming weeks. What else is attractive? Other emerging market stocks are approaching a 9 per cent expected return, as are some Asia ex-Japan ones. Hard currency emerging market bonds also look interesting.
But these require a step up in risk. Traditional bourses are barely forecast to grow more than low single-digits annually. Safer government bonds are going nowhere too. Even my favourite punts right now, such as UK and Japanese shares, or energy stocks, are expected to return 3 to 6 per cent if you believe the models.
Alternative assets may be a better bet for those who can buy them — I can’t on my platform. Based on historic returns versus their listed counterparts, I estimate the so-called “illiquidity premium” for private equity to be 3.5 per cent; for private debt about 2.5 per cent.
Added to the outlook for some equity and credit markets and you’re talking expected returns of 8 to 10 per cent. If a clever reader can tell me how my pension fund can access private assets, I’ll buy them lunch.
Project One Million is not going to be easy. Is it time to beg my editor to allow me to buy individual stocks?
The author is a former portfolio manager. Email: [email protected]; Twitter: @stuartkirk__
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