Why Knight Kiplinger Is Sticking With Stocks

Fed up with roller-coaster volatility in the stock market? Think you’ll never want to own stocks or stock mutual funds again? I understand your feelings, but I can’t endorse them.

I know the case against stocks in a slowing global economy, and I can quote chapter and verse on the lousy decade that equities have just been through. I know the pain that many investors suffered in the 2007–09 meltdown and the recent relapse because I felt it, too (see: Beyond the Lost Decade).

But abandon stocks? No way. An ownership stake in dynamic multinational com­panies, both American and foreign, is still the bedrock of a well-crafted, long-term investment strategy. That is especially true for young adults and people in their middle years -- twenties through late forties. Only folks over 50 should have less than half of their financial assets in stocks, a percentage that should gradually fall to near zero when you reach your eighties (view Kiplinger's Model Portfolios here).

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What’s the Alternative?

There are no risk-free assets except cash, but cash earns essentially nothing and is eroded by inflation. Gold and other commodities? They were great over the past decade, but they’re always prone to wild price swings as speculators surge in and out. After peaking at $1,921 an ounce on September 5, gold plunged 20% in three weeks, and a broad commodity index is down more than 13% from its August high.

Bonds were another star of the past decade, as falling interest rates pushed prices ever higher. But today’s yields are historically low, and when nervous lenders start demanding higher rates on government debt, bond prices will sag.

Real estate? High yields are available in real estate investment trusts, but they come with volatility. The best values for a long-term investor are depressed single-family homes and condos. But unless you’re prepared for the hassles of being a renovator and landlord, there’s no easy way to take advantage.

All of these asset classes have a place in a diversified portfolio, but never to the exclusion of stocks. I am reminded of Winston Churchill’s famous quip that “democracy is the worst form of government, except for all those other forms that have been tried from time to time.” Yes, stocks are an imperfect asset, superior only to every other investment over long periods of time.

Want some dividend income as you wait for prices to appreciate? How about an average of a 2.4% dividend yield from stocks in the S&P 500 -- higher than the ten-year Treasury recently, and more than two times the five-year Treasury coupon. We recently highlighted five blue-chip stocks -- including AT&T, H.J. Heinz and Johnson & Johnson -- with dividend yields that are higher than the interest rates on the companies’ bonds. Many solid utilities are yielding 5% or more, and one of our favorite energy stocks, BP Prudhoe Bay Royalty Trust, was recently yielding 9.8%.

Looking Ahead

Future stock appreciation, of course, is mostly dependent on the earnings growth of the companies you own, as well as on the multiple of those profits that investors are willing to pay -- today a reasonable 12 times estimated 2011 earnings for the S&P 500. Corporate profits surged coming out of the Great Recession, and now they’re cooling off. But mid-single-digit annual gains are likely for years to come, especially for firms with strong global sales in a gradually recovering world economy.

My favorite investment guru, curmudgeonly Vanguard founder John Bogle, thinks that the total return from U.S. stocks -- stock-price gains plus dividends -- will average about 7% a year over the coming decade. I think that’s reasonable, and our forecast at Kiplinger is a tad higher, at 8%. That would be well below the long-term trend of about 10%, but it’s nothing to sneeze at. It would double your money in a decade, and I doubt that any other asset class will do as well.