Are stocks REALLY the best investment?

Great Debates
1

If you read Money magazine or most other conventional wisdom, you have been told that stocks are the best long term investment.

While that was true in the 20th century, can we really expect that rate of growth in the decades to come? Obviously, no one knows.

But they keep pushing the idea of stocks as the best long term investment, even as they recite their disclaimer that past performance is no guarantee of future results.

Also, to get to the root of this question, are the stock and mutual fund companies themselves pushing the idea of buying stocks because that’s what they sell? (Or in the case of Money magazine, those are their advertisers). I need a truly impartial opinion.

2

I do wonder. 10 years ago in July 1998, the S&P 500 was 1120.67. Today it was 1253.39. That’s an annualized return of 1.1%.

Since that’s the time period I’ve been investing, I don’t really see the big deal about index funds. Is there any chance they will reach their promised return rates that make them better than bonds?

3

Most good investment advisors would agree that an intelligent portfolio contains both stocks and bonds, as well as some money market for safety’s sake. I would certainly agree that some brokers and mutual mund companies try to push their investors towards stocks for selfish reasons, i.e. they want to pick up commissions. Look for impartial advice and read up about which companies are trustworthy and which are not.

In the final analysis, the best strategy is to be an informed investor who considers all the options.

4

Of course you seem to have entered at a historic peak and have been weathering a tumultuous decade. You could just as easily look at a twenty year period and start in July '88 at the S&P beginning July at $273.50. Or July '91 at $375.35.

Who knows what the future holds but to beat inflation historically one needs to invest.

5

No they are not the best investment. “Best” is a meaningless term without a qualification. If you have 100k that you are going to use to buy a house next month, than stocks are an awful idea. You need a money market fund.

If on the other hand, your need is long term growth measured in decades and you are tolerant of risk than stocks are a good investment choice for a portion of your moneys.

What you really need is a portfolio consisting of the appropriate mix of stocks, bonds, cash, commodities and some non-correlating assets allocated versus your risk tolerance so as to reside on the efficient frontier, building each category in a core/satellite configuration in accordance with modern portfolio theory.

You will need to periodically rebalance this portfolio due to market movement and alter it’s concentration based on prevailing market conditions and your economic outlook.

Right now, I would be overweight Large Cap, blue chip stocks of the type that have negative 8-10 year returns, dividends north of 2% and are in defensive industries like consumer staples, and health care. I also like information technology. I would tend to underweight energy. Financials though attractive probably represent a value trap. I would be about 30% international with about 10% of that in the frontier sector.

Hope that helps.

6

Very true, but I’m not sure what I could do about that. Not invest in stocks I suppose, which is the original question.

7

The efficient frontier is a nice approach in theory, but as has been mentioned, past performance–or more specifically, correlation, return and volatility–is no guarantee of future results. You can make all kinds of calculations with the assumption that things will behave like they have in the past, but you have to be very weary of lulling yourself into a false sense of security. In a way, quantitative finance is a very dangerous thing because it lets you calculate a lot of decimal places without having to examine the assumptions of your models.

8

You are exactly correct. Beta, is a poor substitute for a true measure of risk. You’ll notice my suggestion is not fully dependent upon MPT. Instead I’m seeking the overlap between portfolio construction on the efficient frontier, an endowment style core/satellite approach, noncorrellating assets, and predictive economics. In this fashion, a failure of MPT to project past correllation and risks into the future does not automatically spell doom for the portfolio.

9

I failed to clearly make my point obviously. Allow me to try again.

You are looking at your past experience over this decade and using that imply something about future performance - these ten years in aggregate have been lackluster so maybe the next ten years will be too. Meanwhile past history over a longer time course has shown that stocks perform best. Now neither time course is actually an assurance of future events but a longer view is likely less subject to the effects of temporary volatility.

It also begs the question of, absent a crystal ball, what you should do instead.

Let us look at some indicies (source - Charles Schwab behind my sign in):

The Aggregate Bond Fund Index is up an average annual of 3.68 for the past 5 years and 5.68 for the past ten.

The S&P up 7.58 for the past 5 years and 2.88 for the past ten.

Russell 2000 up 5.53 past 5 years and 10.29 past ten.

So bonds have lost to both stock indices over the past 5 years, lost to one of them and beat one over 10 year and 20 year performance has already been referenced. Past performance overall favors stocks to bonds. For what that is worth.

Now I have heard the argument made that you should use your money to pay down your mortgage faster (e.g. making an extra payment per month, and assuming that you have a mortgage) and that makes some sense, albeit you create a very illiquid savings vehicle. Still, a goal of being able to pay for the kids’ college years may be partly served by not having to make mortgage payments those years. I still like the tax savings of a 527 though.

Scylla’s point is cogent: “best” is a meaningless term unless you define your circumstance, your particular goals and your risk tolerance. No one knows for sure if the next ten years will act like the last five, the last ten, the last twenty, or none of the above.

Personally I believe in: maxxing out in my company’s 401-K (and choosing a selection of large and small cap funds with giving serious consideration to low cost index funds as offered, international funds, and smaller amounts in bond funds); funding the kids’ 529’s college funds early; having a 15 year rather than a 30 fixed rate mortgage; and rolling my own with individual more speculative picks with the rest, rarely selling a winning pick before a year and usually holding a pick much longer (avoiding short term capital gains). Once I have my fairly safe diversified selection building gradually in my retirement funds, and the kids’ colleges on track for being paid for (both in tax protected manners) then I have a high tolerance for risk with the rest, such as it is. That’s best for me. Your mileage may vary.

10

It occurs to me that we may not be addressing the op’s overarching point: is the nature of the world’s economy likely to be (or has become) such that the basic principal that overall stocks appreciate is broke of its historic long term behaviors? Or perhaps even more narrowly, is such true for US stocks?

I think not and such statements seem to be the converse of those who believed that the internet bubble was somehow “different” than bubbles of the past, and would not pop. Claims that this time it really is different, and is a break with all historic precedence are invariably false. Bubbles pop and dips come back up. To be sure one needs to invest globally but even large cap “American” picks accomplish that as those are almost all actually multinationals.

11

It seems to me that you are assuming a bad model of investing here. You don’t buy a basket of stocks at time X and then sell them at time Y. You do dollar cost averaging, which smooths out fluctuations in purchase price, and you rebalance your portfolio from time to time in order to keep your asset distribution in line with your current goals and situation.

12

as to purchase a portfolio of stocks in July 1929. Then the Crash comes-how long do you have to stick it out? (Until you break even)?

13

Well, yeah. Why not? If you’re completely shot and so is everyone else and the market is virtually destroyed, I’d say you hold onto the worthless paper you have. It can ONLY get better.
Right?

14

About 25 years. Of course you would have done moderately well buying in 1932! And also if you look at that chart, if you had been gradually investing over the previous ten to fifteen years then you had recovered within ten and were roughly five times up by thirty years out. Hence the wisdom of dollar cost averaging and taking a long view.

15

I started buying stocks about two years ago–mostly big index funds, about 30% international, with a couple of individual buys.

An equivalent strategy for me over this time would have been changing the same amount into $20 bills, stuffing 99% of them into a mattress, and shoving the rest straight up my ass. It doesn’t really bother me that much; at this point in my investing career, the important thing is that I’m saving, not that I’m getting a big return.

I’m worried enough about a big crash that I’ll probably deviate from my 100% stock strategy earlier than I thought I would. (I’m 32, so I’ve been willing to take the risk so far.)

16

Another thing too is you can’t just go by the stock prices to determine return - there are distributions and dividends. My 401k has lost a lot in “face value” but still paid more than $5,000 in gains and dividends last quarter, and my other non-401k mutual funds have recovered about as much in “distributions” as they’ve lost in face value (“distributions” in quotes because I’m honesly unclear as to why they paid so much).

17

There is no “big deal”. Index funds simply allow you to invest in a porfolio of stocks representative of a particular market index (ie S&P 500) without having to buy those stocks individually. It is a way of distributing risk, not a magic lottery ticket.
People don’t seem to grasp the idea of what a “best” investment means and assume that best simply means highest returns. Higher returns also means higher risk. Most people just see the returns.

Stocks generally are a good investment, however they are riskier than bonds, CDs or your savings account. And there is a certain amount of speculation involved with stocks because they are tied to businesses and businesses can suffer downturns. That’s why people invest in mutual funds because it lets them distribute risk accross multiple stocks.

18

There’s that but index funds are usually compared to mutual funds as the means to buy that portfolio. Management fees for an index fund are substantially less than for a mutual fund. Mutual funds usually charge 2% per year in those fees; index funds usually less than 0.5%. Few end up beating market averages with regularity but even if they did, they’d need to beat them regularly by more than 1.5% to win. No magic.

19

While nothing can guarantee future results, past performance is the best predictor of future results.

20

Beta (especially if you have several using the arbitrage pricing model) is a pretty good measure of risk, if and only if you are estimating and interpreting it properly. I don’t think this is a trivial point, but I don’t know how much we need to go into mathematical finance given the OP.