Should You Still Invest in Stocks?

10 Jun

Posted in Experts by Roger, the Amateur Financier No Comments

In the latest issue of Time Magazine, there was a rather interesting article considering three different financial experts’ views on how stocks will perform over the long term. (You can find the article here on the Time website; luckily, they haven’t (yet) taken the advice they put out a few months ago, about charging tiny fees any time people wanted to view their content.) In case you don’t feel like reading the whole thing, what follows is my synopsis and thoughts on the experts’ opinions that were discussed.

The article opens with some interesting background; apparently, prior to the 1920′s, bonds were considered the only good long term investment, with stocks regulated to speculation. That is, until Edgar Lawrence Smith did some research and found that in almost every twenty year period previous, stocks had actually beaten out bonds in total investment returns. The Great Depression made it hard for many people to believe this point for decades, but eventually it became a commonly accepted fact: stocks will outperform bonds over the long (multi-decade) term. (Although, I’ve already mentioned that I’m afraid the ‘Great Recession’ will be held up as an argument against stocks in the future; the Time article mentions the oft-cited note that over the past ten years, an investment in the S&P 500 would have actually lost money, for example.)

A staunch defender of this notion is Jeremy Siegel, professor of Finance at the University of Pennsylvania’s Wharton School. He’s also the author of Stocks for the Long Run, an examination of stock and bond performance going back to the turn of the century; that is, the turn of the nineteenth century, in 1802. His findings were the same as Smith’s: given a multi-decade time frame, stocks almost always come out ahead.

That small almost does open the door to critics of a stock-centric portfolio, though. The article goes on to mention two of them: Robert Arnott and Zvi Bodie. Arnott is a money manager who helps to manage a ‘go anywhere’ fund for Pimco, which can invest in just about anything. He noted in the Journal of Indexes that investments in 20 year Treasury bonds in March 1969 would have beaten an investment in stocks over the same period. His primary argument is that you need to look at the value of an asset you intend to purchase, and buy the cheap ones.

Zvi Bodie, on the other hand, seems to harken back to the pre-Edgar Smith days, maintaining that when saving for retirement, investers should avoid stocks entirely and instead simply invest in Treasury Inflation Protected Securities (or TIPS). He argues in Worry-free Investing that since they are (a) back by the US government, (b) increase their payments according to inflation, and (c) pay a fixed interest rate besides, they make the ‘perfect’ investment.

My Thoughts

First, with respect to Mr. Bodie, the prospect of investing in a vehicle that will only return about 1-2.5% beyond inflation isn’t that appealing, especially when stocks typically yield 5-6% beyond inflation. It’s an effective tactic, but only if you’re willing to save at least twice as much, and possibly four or five times as much, as you would have to save with stocks and other growth investments. Don’t get me wrong, TIPS do have their place in many portfolios, but mostly as a hedge against inflation and a way to secure the money built with riskier benefits, not the entire portfolio.

Arnott’s point is a bit harder to dismiss completely; if you buy any asset when it is overpriced, it’ll be harder to recoup your investment and show any gains. The best solution to that would be to hold both bonds and stocks, and buy whichever one is undervalued. If you regularly rebalance your portfolio, you’re doing this already; selling the assets that perform the best and buying the weaker ones when they are low. In this way, you keep from buying too much of any asset that is on the rise and sell your stake in any that are rising, allowing your portfolio to more easily weather any economic storm. As long your desired asset allocation is a good one for your financial goals, this will help to keep your portfolio progressing towards your goals.

When it comes to investing for retirement, especially if that retirement is decades away, it’s hard to find fault with Siegal’s basic premise. If you hold stocks for the long term, you will be rewarded eventually with higher performance over time.