This article, written by Raul Elizalde president and chief investment officer of Path Financial LLC Investment Management in Sarasota, Fla., is part of Morningstar's "Perspectives" series, which is a series of articles written by third-party contributors. The views contained herein are those of the author(s) and not necessarily those of Morningstar. If you are interested in Morningstar featuring your content on our website, please find more information here. This article was originally published in November 2012 on Morningstar.com and AdviceIQ, which features fun-to-read, yet highly analytical, articles explaining important financial issues.
You keep hearing that stocks are the best investment for the long run. But the evidence for that is far from clear-cut. Luck is a factor in successful stock investing.
If you have 140 years ahead of you to manage your portfolio, U.S. stocks may be an excellent choice of assets. If you don’t have that kind of time, don’t think of them as a sure thing.
On this topic, opinions are divided, evidence is inconclusive, and our own research suggests that luck has a lot to do with success.
Stock fans have Jeremy Siegel on their side. The Wharton professor and author of Stocks for The Long Run, studied data going back at least 140 years and concludes that “stocks are the best place for long-term investors.”
Other luminaries like Robert Shiller, Yale professor and author of Irrational Exuberance, are more skeptical. Prof. Shiller is best known for warning in the 2000s that the housing market bubble would inevitably burst and inflict great economic pain. He often cautions that stock markets become overpriced from time to time.
In that sense, the difference between the two camps is about investment horizons – the long-term view versus the short-term view. But how long is the long-term view, and when is it relevant for the individual investor?
Looking at 140 years of stock market history may be meaningful to some institutions or to a handful of families that can track their fortunes back a couple of centuries. But the vast majority of investors have investment horizons that are radically shorter.
Most investors accumulate wealth during their productive years to pay for retirement and pass along whatever is left to survivors. Since it takes time for most people to build an investable portfolio, managing financial assets for growth rarely spans more than a couple of decades before the focus shifts to financing retirement and accomplishing legacy goals.
Therefore, it means little that a dollar invested in the stock market in 1871 has grown 10,000-fold in real terms. Since most regular people measure their performance over much shorter periods, the real question is whether stocks can deliver investment success within a timeframe that matters.
The evidence is sketchy. Using data provided by Prof. Shiller, we calculated the return of large-cap U.S. stocks, including dividends and after inflation, for rolling 10-, 20- and 30-year periods since the beginning of the 20th century. We found no assurance that stocks can produce consistent returns within realistic investor timeframes.
Stocks seem to deliver positive returns over any 30-year period – a reassuring conclusion, but the size of the returns has averaged as low as 2% per year (for the period 1902-1932) to as high as 11% (1932-1962).
Stocks held for 20 years are less predictable. They yielded nothing between 1901 and 1921, but gained an annual average of 14% between 1980 and 2000.
Getting positive returns from a stock portfolio held for a mere 10 years is simply a matter of luck. Whoever held stocks between 1919 and 1929 achieved a stunning 20% per year, while those who held them between March 1999 and March 2009 were faced with a ruinous negative 6% return.
The entire history of U.S. stocks in a single chart reveals an admirable long-term pattern. As Prof. Siegel has demonstrated, they rose 10,000-fold since 1871 at an average of over 6.5% a year. But hidden in this history are at least three 20-year periods – half of the chart time span – where stocks went nowhere: 1901-1921, 1929-1949, and 1962-1982.
The chart also shows that another period of stalled performance is unfolding today.
How long will stocks remain stuck in the current range before rallying again? That is the question many analysts are trying to answer. Behind that question, of course, lies the assumption that there is a fundamental feature of the market that will force it to eventually resume its upward climb, which might or might not be true.
It is impossible to say when the stock market will take flight again. Assuming that it will, one difficulty is that we don’t know where the range boundaries are. If the market started stalling after the 2000 peak, it can go up considerably from current levels, come back down, and end up at the 2000 starting point by 2020. If it started stalling in 1997, downside seems more likely than upside for the next few years.
None of this is truly helpful for making investment decisions over a year or two. But realizing that U.S. stocks are not an investment panacea is crucial for successful retirement planning. Counting only on U.S. stocks to grow a portfolio needed to finance expenses during retirement can be dangerous.
It doesn’t need to be that way. Today, investors have access to many risk assets beyond U.S. stocks. Prudent diversification can go a long way toward countering some of the disadvantages of placing all bets on U.S. stock returns that are uncertain over timeframes that matter to investors. Multi-faceted portfolios that include foreign and emerging market stocks, high-yield debt, commodities, currencies and other assets should be central to investors’ quests for safer returns.
Realizing this may be very difficult today. After three years of phenomenal U.S. stock performance, investors are tempted to conclude that Prof. Siegel is right by claiming that U.S. stocks are unbeatable. Mere chance will have to play a big role for that to be true.
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