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Thursday, December 31, 2009

Stocks for the long run?

Following conventional wisdom has led a generation of investors down the road to ruin. That wisdom had us believing that over the long run stocks produce the highest returns, that a diversified stock portfolio protects you against loss and that the risk of owning stocks is small if you hold them for a long time.

We now know that conventional wisdom is wrong. While the number of decades in which equities in the U.S. underperform other asset classes may be small, the size of the shortfalls, when they occur, can be huge. For the first decade of this century it is highly likely that the return on U.S. stocks will be negative. For those who are near retirement, the shortfall is devastating; they might not get a shot at making up the loss in their lifetimes.

Diversification is useful, in varying degrees, most of the time. But there are occasions when all stocks dive simultaneously and putting your eggs in different baskets doesn't save you.

Like a broken record, the CNBC sages are still telling young people to buy stocks because if you have a long time horizon, you don't have to worry about these market fluctuations. While this sounds like a reasonable theory, it's wrong even if you're young. The so-called experts fail to account for the potential severity of the underperformance when stocks fall.
--from "Unconventional Wisdom" by Steve H. Hanke (02.25.09)

By sheer coincidence, I came across Hanke's 11-month old article today (January 31, 2009), when the Chart of the Day shows the returns from the Dow decade by decade:
Hanke's advice has been to buy gold and Treasury Inflation Protected Securities ("TIPS"):
If you followed my columns in 2008, you would have bought gold and inflation-indexed Treasurys. I'm not veering from this advice. Forget conventional wisdom and ignore play-by-play economic commentators. Buy federally guaranteed, inflation-protected TIPS and sleep soundly.
Today's Chart of the Day shows that the losses of the '30s were followed by gains in the '40s, '50s (huge gains), '60s, and even the '70s (slight gains) before the huge gains of the '80s and '90s. Will history repeat itself? Will the losses of the '00s be followed by gains in the '10s and '20s?

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