The Past Is Still a Guide
I prefer history, for all its flaws, to my own subjective guesses about the future.
By James K. Glassman, Contributing Editor
From Kiplinger's Personal Finance magazine, May 2009
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The witty Danish physicist Niels Bohr once said: "Prediction is very difficult, especially about the future." The future is, of course, unknowable. No one has ever been there. But our lives require forecasts about what it will be like, and we have to base those forecasts on something. Our choice, usually, is history. And so it is with investing.
When you invest, you forgo the immediate gratification your money could purchase and instead put your cash away, to be recovered later, when, you hope, it will be worth more.
The key word is hope, but the past teaches us that:
Stocks have outperformed bonds by a wide margin.
Stocks have been volatile over short periods but stable over long periods.
A diversified portfolio provides extra stability.
Therefore, the best strategy is to buy a diversified portfolio of stocks and hold for ten years or more.
Short-term investing is risky. From 1926 through 2007, a broadly diversified portfolio of large-company stocks (as represented by Standard & Poor's 500-stock index) produced losses in 23 out of 82 calendar years. But when you examine returns over holding periods of ten years (that is, from the beginning of 1926 to the end of 1935, from 1927 to 1936, and so on, up to the present), you find that losses occurred only twice.
Minimal losses. The negative periods were during the Great Depression: 1929Ð38 and 1930Ð39. The declines were small: 0.89% and 0.05% annualized. Over the 73 overlapping ten-year periods between 1926 and 2007, a portfolio of large-capitalization stocks has failed to at least double in value only 19 times. These statistics -- and others I cite here -- come from Morningstar's Ibbotson subsidiary.
Enter the disaster of 2008. The S&P 500 plunged 37% in 2008, and the ten-year period that ended December 31 became the worst since Ibbotson began keeping records: an annualized loss of 1.4% -- or roughly 4% after taking inflation into account. Since then, stocks have continued to tumble. The 120-month period that ended February 28, 2009, produced the worst real loss (5.8% annualized) of all 880 such periods studied.
A single outlying result should not invalidate a strategy based on more than 80 years of history. But the results of the past decade do make investors extremely nervous, and with good reason. Is the past still a guide to the future in investing? Doubts are growing.
Perhaps some profound change has occurred in the economic and social fundamentals that underlie financial investments, making history an invalid prologue. Perhaps the United States is growing weaker and can no longer compete with China. Perhaps we are following a disastrous public-policy route -- failing, for example, to prevent health-care costs from gobbling up the entire economy. Or perhaps the markets are looking to the future -- to huge deficits or the probability of more serious terrorist attacks.
While I share such concerns, I don't buy the notion that it's different this time. I prefer history, for all its flaws, to my own subjective guesses about the future.
Still, we need to recognize that history has serious limitations. The world is not a wholly rational place. Peter L. Bernstein, in Against the Gods (Wiley, $19.95), his brilliant book about risk, quotes the English writer G.K. Chesterton: "The real trouble with this world of ours is not that it is an unreasonable world, nor even that it is a reasonable one. The commonest kind of trouble is that it ... looks just a little more mathematical and regular than it is; its exactitude is obvious, but its inexactitude is hidden; its wildness lies in wait."
This wildness is what we are witnessing today. Its foundation is mass psychology -- our tendency to get caught up in a craze, which, in retrospect, appears illogical in the extreme.
Discuss