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Epoch Times
05-05-2025
- Business
- Epoch Times
What Is the Buffett Indicator?
By Charles Lewis Sizemore From Kiplinger's Personal Finance Buy low and sell high. That sounds easy, right? The problem is defining what exactly 'low' means. How do you define whether the stock market is cheap or expensive? Precisely valuing the market is exceptionally hard. It involves making guesses on several key assumptions such as interest rates or growth in earnings per share. So investors—even all-time greats like Warren Buffett—tend to fall back on 'quick and dirty' metrics. These metrics are designed to tell you whether the market is generally cheap or generally expensive. But they aren't intended to be used with surgical precision. Related Stories 4/22/2025 3/30/2025 It just so happens that the 'Oracle of Omaha' has his very own quick-and-dirty metric, the 'Buffett Indicator.' The Buffett Indicator is a broad measuring stick of whether the stock market is overvalued or undervalued relative to the size of the overall economy. Buffett famously referred to this indicator as 'probably the best single measure of where valuations stand at any given moment' in a 2001 interview with Fortune magazine. It is absolutely not a tool for short-term trading. But it can be a really solid tool for long-term allocation decisions, such as for a 401(k) plan or even in an institutional portfolio like a pension plan. What Is the Buffett Indicator? The Buffett Indicator is calculated by dividing the total market capitalization of a country's publicly traded stocks by its gross domestic product (GDP). Market cap is the total value of all outstanding shares of every publicly traded company. For example, Microsoft's (MSFT) market cap is $2.6 trillion. That's the total value of all Microsoft shares in existence. We add up every other listed company to arrive at a total market cap of a country. If we were putting the Buffett Indicator to work in the United States, we would use the Wilshire 5000 Total Market Index. The Wilshire 5000 includes far more companies than the commonly quoted S&P 500 Index or the Dow Jones Industrial Average. We would divide this comprehensive measure of nearly all publicly traded American stocks by U.S. GDP. In short, the Buffett Indicator equals total market cap divided by GDP. Its utility is based on the idea that, over time, stock values should roughly move with the economy. When this ratio is high, it suggests that the market's valuation is running ahead of the actual economic output, meaning the market is potentially overvalued. A low ratio could indicate undervaluation and possibly a good buying opportunity. It's important to note that the number in a vacuum doesn't mean much. There is no absolute level that means the market is cheap or expensive. You have to compare it over time and look for trends. Historically, the Buffett Indicator has hovered around 75 percent to 90 percent. Values above 100 percent may suggest the stock market is overvalued, although some argue that changes in interest rates, profit margins and globalization have shifted what counts as a 'normal' ratio. The Buffett Indicator has certainly trended higher over the past few decades. The Buffett Indicator in Action Research site GuruFocus calculated the traditional Buffett Indicator along with a modified Buffett Indicator that attempts to adjust for the Federal Reserve's aggressive monetary policy since the 2008 meltdown. Given that Buffett views 100 percent as a rough threshold for overvaluation, the market has spent much of the past 20 years in highly expensive territory. Of course, today we're well above that level. Even after the recent stock correction, the traditional Buffett Indicator is above 190 percent. And the Fed-adjusted Buffett Indicator is sitting at 155 percent. When Buffett endorsed it in Fortune, the ratio had soared to record highs during the dot-com bubble. The indicator fell in the early 2000s following the market crash. But it has climbed steadily in the decades since, often reaching levels well above its historical average. Takeaways From the Buffett Indicator Does the Buffett Indicator's lofty level suggest a market crash is imminent? No, and that's not how the indicator is designed to be used. It's exceptionally poor as a short-term timing tool. Had you dumped your stocks due to overvaluation in the index, you would have missed out on one of the longest and most extreme bull markets in history. But it's a useful tool for understanding where we are in the broader market cycle. You should use it as you balance your portfolio between stocks, bonds, cash, gold and other assets. If you're heavily invested in stocks right now, you might want to look at diversifying your portfolio by upping your exposure to other asset classes. And, likewise, when the indicator dips into 'cheap' territory, you might consider increasing your exposure to stocks. ©2025 The Kiplinger Washington Editors, Inc. Distributed by Tribune Content Agency, LLC. The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.
Epoch Times
28-04-2025
- Business
- Epoch Times
What Is the Rule of 72 and How Can Investors Use It?
By Charles Lewis Sizemore From Kiplinger's Personal Finance If you've dabbled in investing, you've likely heard of the 'Rule of 72.' It's a back-of-the-envelope metric for calculating how quickly an investment will double in value. Most financial metrics are too complex to be done in your head. You'd likely need a financial calculator or a spreadsheet to calculate the internal rate of return, yield to maturity, or common risk metrics like beta or standard deviation. The beauty of the Rule of 72 is that it can be calculated by the average 10-year-old. Let's take a look at what the Rule of 72 is, how it works and how it can be used in investing and financial planning. What Is the Rule of 72 in Simple Terms? The Rule of 72 is a straightforward formula that provides a quick-and-dirty approximation of how long it will take for an investment to double in value assuming a fixed annual rate of return. It's a solid tool for estimating the effects of compound interest and can be used to gauge the potential growth of your investments over time. Related Stories 3/5/2025 7/6/2024 The formula for the Rule of 72 is incredibly simple. You divide 72 by the annual rate of return you expect to earn on that investment. For example, if you expect an annual return of 9 percent, it would take approximately eight years for your investment to double (72 divided by 9 equals 8). What Are Specific Examples of the Rule of 72? Getting more concrete, let's say you own an S&P 500 index fund and you want to map out a few scenarios. If the index rises at its historical average of around 10 percent, you'd double your money in about 7.2 years (72/10 = 7.2). If you believed that the S&P 500 is more likely to return, say, 15 percent due to strong earnings or continued tailwinds from the best AI stocks, you'd double your money in 4.8 years (72/15 = 4.8). And if you believed the S&P would return a more mundane 5 percent due to, say, a recession, you'd double your money in 14.4 years (72/5 = 14.4). In 2024, the S&P 500 generated a total return (price change plus dividends) of 25 percent. The Rule of 72 would suggest your investment in the S&P 500 fund would double at that rate in 2.9 years—but that's assuming that rate of return stays constant. At last check, the S&P 500 was down 1.5 percent a quarter of the way into 2025. The Rule of 72 can also be used to assess the impact of inflation on your purchasing power. If you want to determine how long it will take for the purchasing power of your money to be cut in half due to price pressures, you can use the same formula. Let's say the inflation rate is 3 percent. You could divide 72 by 3 to get 24 years. Assuming a 3 percent rate of inflation, your purchasing power would be cut in half in 24 years. The most recent Consumer Price Index report put headline inflation at 2.8 percent on an annual basis. Using the Rule of 72 at that rate, your purchasing power would be cut in half in 25.7 years. But, again, that's assuming the inflation rate stays the same. Why Should I Use the Rule of 72? The benefits of the Rule of 72 are obvious. It's a simple formula that anyone with elementary school math skills can calculate. It doesn't require a Wharton MBA or CFA Charter. It also allows you to set realistic expectations for your investments and can help you determine whether your financial goals are achievable within your investment time frame. You can also use the Rule of 72 to compare different investment options. For instance, if you're deciding between a stock fund and a bond fund with two very different expected returns, the Rule of 72 can help you assess which one gets you to your financial goal faster. Remember, though, the Rule of 72 is designed to be a rough estimate and its assumptions aren't always realistic. It assumes a constant rate of return, and stock returns are anything but constant. The average return is far from indicative of the return you're likely to get in any given year. It also doesn't account for taxes, fees or other expenses that can chip away at your returns. And, like all financial models, it's only as good as its inputs: garbage in, garbage out. While by no means a comprehensive analysis, the Rule of 72 is a useful tool that provides a quick and easy way to estimate the time it takes for an investment to potentially double. It's valuable in financial planning and in comparing investment alternatives. And it's something even someone new to investing can put to work. ©2025 The Kiplinger Washington Editors, Inc. Distributed by Tribune Content Agency, LLC. The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.
