Beyond Buy-and-Hold #9
By Rob Bennett
People are getting antsy. We were told that stocks always provide great returns in the long run. But stock investors have now experienced a Lost Decade. Each day more and more of us are asking: ?When does the long run kick in??
There are two answers to this question.
The first answer, the one that responds only to the question directly asked, is: ?We have one more price crash to endure and that is likely to take place within the next five years. From that point forward, long-term returns are likely to be awesome.?
The second answer, the one that addresses the confusion at the root of the question and thus provides more genuinely helpful guidance is: ?Stocks have been performing over the past 10 years precisely as anyone who was familiar with the historical return data would have expected them to perform. The strong likelihood is that they will continue to do so and that is not good news for those heavily invested in stocks today.?
Truth versus perception in the stock market
It?s often necessary to parse the words of those who claim to offer expert investing advice. Is it true that stocks always provide good returns in the long-term? There is a legalistic way in which this claim can be said to be true. It is not even a little bit true in the sense in which the vast majority of middle-class investors believe it to be true.
The Stock-Return Predictor tells the story. The Predictor runs a regression analysis of the historical stock-return data to identify the most likely annualized 10-year, 20-year and 30-year returns for stocks starting from any of the possible starting-point valuation levels. Please enter the P/E10 value that applied in January 2000 (that?s ?44?) and compare the most likely return numbers for 10 years out (2010) and for 30 years out (2030).
The stock valuations that applied in January 2000 were the worst we have ever seen in the history of the U.S. market. But those 30-year numbers are not bad at all. The most likely annualized return in 2030 for those who bought stocks in 2000 is 5 percent real. That beats any other asset class available to the middle-class investor. So it?s true! Stocks really are always best for the middle-class investor.
When you heard the promise that stocks will do well for you in ?the long run,? were you thinking that that meant 30 years out? Most middle-class investors with whom I have discussed the matter think of ?the long run? as meaning five years out or perhaps 10 years out. I have never yet met one who interpreted the claim that stocks always do well in the long run as meaning that their stock investment would end up paying off at the end of three decades.
The example of recent experience
If you bought stocks in 2000 thinking that the investment was going to pay off in five years or ten years, you are disappointed today. In the event that we experience another crash sometime over the next few years (this is likely, according to the historical data), you are going to be so disappointed at that point that you will likely sell most of your stocks. Selling violates the warranty. Sell your stocks and any realistic basis for your belief that you will ultimately obtain a good return on your investment goes ?Poof!?
To be sure of getting a good return from stocks, you must be able to hold stocks for the long run. Saying that you are going to do so is not enough. You must actually do it. And the key to doing it is having a good idea in advance of how your investment is going to perform in all of the various time-periods.
The Buy-and-Holders advance an important insight when they tell us that stocks always perform well in the long run. Those 30-year numbers matter. But it is critical that all investors know that the 30-year numbers and the 10-year numbers are very, very different numbers. A return of 5 percent real is darn good. The most likely 10-year number — a negative 1 percent real — is horrible. People seeking to become effective long-term investors need to know both the good and the bad news about buying stocks at various prices points.
If everybody knew these numbers, stock investors would not be disappointed today. The calculator is telling us that stock investors have actually been a bit lucky over the past decade. Given how high prices had risen in 2000, the most likely annualized 10-year return was a negative 1 percent real. Stocks have performed a bit better than they should have been expected to perform over the past 10 years. That?s the little-appreciated reality.
When you think of investing in stocks, or investing for the long run, what is your time horizon? What is your definition of the long run? Do you think stocks always work in the long run?
Rob Bennett often writes on behavioral finance. His bio is here.