How It Works.

Again, here is the link to the spreadsheet:

https://docs.google.com/spreadsheet/pub?key=0AmMlf3bsV3rFdFQ3eDBDeXRCTEU4a2FtOHlpUFMtM0E&output=html

The most difficult task I faced in creating the spreadsheet was how to calculate average returns over time.  Simplistic calculations yielded extreme distortions. For example, dividing the net portfolio increase by the total net investment at the end of a long time series greatly understates returns compared to inflation.  This is because the cumulative effects of inflation over, say, 40 years are compared to final returns mostly generated far more recently.  I finally hit upon a weighting system.  This is a factor that combines the BAA interest rate for a given year with the dollar total invested that year.  Dividing the sum of those factors by the total amount invested over a period of time yields an average return for that same time period.  This average return can then be applied to the final portfolio value to calculate a weighted total investment.  This weighted investment is the amount of money that would, compounded by the average interest rate over a time period, yield the final portfolio value.

Typically, a high interest rate will generate a far larger factor than a low one.  Also, that high interest rate, toward the end of the series, will create a higher factor than the same interest rate early on (typically less money being invested earlier).  The advantage of the factor is that high interest years have greater weight, as do years with high dollar investments.  Years with high interest rates AND high dollar investments weigh the most.  Note also that investments as long as 30 years in the past are still relevant, as the BAA yield is a 30 year yield.  Bonds purchased in 1985, for example, would still be generating interest today.

To put this in other words, the weighted investment calculation converts the many yearly investments into a lump-sum equivalent.  This would be a single initial investment that would yield the same long-term results.  The advantage of weighted investment is that the cumulative effects of compounded interest and compounded inflation can be seen side by side.  The very good news is that inflation's effect diminishes steadily over time.  This is, perhaps, counter-intuitive, but actually makes good sense.  Inflation compounds at a far lower rate (2.5% or so yearly) than the bonds income does (7.65% or so).

The base spreadsheet assumes a steady injection of inflation-adjusted funds every year.  In most time series, the predictable spread of the BAA yield over inflation quickly brings the portfolio into the black. Every single time series has positive results for 10, 20, and 30 year periods.  By 20 years, nearly every time series outperforms inflation robustly.