Friday, September 3, 2010



Despite the oft-repeated assurances to the contrary by financial “experts,” maybe stocks aren’t a sure thing, just can’t miss as long as you are “in it for the long run (whatever that means)” investment.

It seems that the entire personal financial advisory business (Okay, maybe not the entire business, but, rather, that portion of the financial advisory business composed of knaves and charlatans…a substantial portion, to be sure.) is given to endlessly and mindlessly repeating the canard that “the stock market returns 11% per year over the long run, delivering returns far superior to those available in bonds, cash, or other alternative investments.” When asked where they got this figure, its brighter advocates cite an old Ibbotson study that tracked returns on the S&P 500 from 1927 to, depending on whom you talk to, 2007. The less alert among those pushing this story merely shrug their shoulders, or reply that “Everyone knows…” (Any time your opponent in any kind of debate starts with “Everyone knows…”, relax; you have won the debate. But I digress.) The Ibbotson numbers are doubtless true, but the financial profession’s tendency to take these numbers and run with them to the degree it has is silly and irresponsible. History is history and distant history is distant history. No one invests in the past; everyone invests in the future. If one listens closely enough to, or reads deeply enough into, pitches based on that magic 11% number, one will hear such caveats, but only quickly and quietly.

Leave aside the mountebanks for a moment; even very smart and otherwise perspicacious investment gurus have fallen for this “stocks for the long run” baloney. Case in point is Dave Ramsey (XM 165, M-F, 11:00 AM to 2:00 PM central time and on local stations throughout the country at the same time), a man for whom I have the utmost respect and with whom I agree on just about everything, financial and otherwise. Dave is given to glibly advising callers to put most, or all, of their money, beyond an emergency fund, in “good growth mutual funds” and then enticing them with future values of said nest eggs using a compound interest rate of 12%, a return he assumes for stocks “for the long run.” While Dave, smarter than the average bear, cautions that there is some risk in stocks, he quickly brushes aside such caveats and goes back to his 12% return assumption. Bruce Williams, another financial guy on the radio for whom I have boundless respect (See my 8/19/10 post “LET’S SPEND IT, LEND IT, SEND IT ROLLING ALONG!” PART II.), makes a similar “stocks can’t miss in the long run” argument. Bruce even tells people to always keep a mortgage outstanding so that they can arbitrage mortgage rates and “historical” 10% + returns on stocks. (Point of clarification: Dave Ramsey would NEVER agree to such a strategy, just in case this comes up.)

Needless to say, anyone who has invested his nest egg exclusively, or even moderately heavily, in stocks has come to rue any type of reliance on the anodyne assurances that stocks are the place to be “for the long run.” But I wanted to quantify, at least to a limited extent, the emptiness of the “Put it all in stocks and wait for the long run” argument. So I looked at stock returns for the Dow, S&P, and NASDAQ for each rolling ten year period (When “advisors” speak of “the long run,” they generally speak of ten year periods; for a lot of people, the “long run” is far shorter than that, especially when the excrement hits the air motivation device.) ending in month’s ends from March 2006 until August 2010; i.e., those rolling ten monthly year periods starting March 1996 through August 2000. I looked at the compound annual growth rates (“CAGR”s) of the indices’ levels (I did not include dividends; more on this flaw later.) over that period. Here are some numbers I derived.

Observations: 55
Average CAGR 2.80% 1.60% 1.20%
High CAGR 7.40% 7.20% 7.80%
Low CAGR -2.70% -5.10% -7.10%
% negative CAGRs 36.40% 41.80% 41.80%

(Okay, the blog mechanism does not allow for decent reproduction of tables. If you read carefully, there are three columns, Dow, S&P, and NASDAQ. The numbers follow in that order. The highlights are in the next paragraph.)

Think about this. For the observed periods, the Dow, S&P, and NASDAQ delivered negative returns before dividends in 36%, 42%, and 42% of the ten year periods considered, respectively. In none of those ten year periods did any of the indices even approach, before dividends, the 11% returns cited ad nauseam by brokers and other stock enthusiasts. Some of the negative returns were downright frightening; if you invested in the NASDAQ, for example, for the ten years ending 2/28/10, you lost 52% of your money. But I’m sure there are many financial “experts” who will assure you that everything will work out if only you stay in “for the long run.”

Are there flaws in my “study”? Sure. The most obvious is excluding dividends. But assume a 3% dividend rate for any of these indices, or assume a 4% or a 5% dividend rate, if one wants to make such an outlandish assumption for ten years, and one still did not approach even a 10% annual return on average, experienced very few such returns over any ten year period, and still experienced at least a few negative ten year returns for the S&P and NASDAQ. Even assuming a generous dividend, a holder of money market funds or short term treasuries would have outperformed stocks in many, probably most, cases, not even adjusting for risk.

Another flaw is the short time period; I didn’t look at 70 years, but only 14 years. But they are the most recent ten year periods and, in almost all statistical work, the most recent experience should be given more weight than distant experience. Further, some might argue, these were some very troubled years. But the “experts” tell us that in the long run stocks even weather things like the Great Depression or the (and I hate this cutesy-pie term) Great Recession from which we are emerging. So what, then, if these were tough years? Can these notables assure us that the next ten years will not be similarly tough? They might trot out the “reversion to the mean” argument, a good statistical device but not much comfort in people’s actual experience. And there are two more minor flaws in the data; I had to “fudge” the ending date for the ten year periods ending 9/30/97 (I used 10/1/97) and 1/31/08 (I used 2/5/08) due to ready availability of data. I don’t know how much using the proper ending points would have affected the outcome; I assume not much.

So there were flaws in the “study,” which could have been corrected had I found doing so passed any meaningful cost/benefit analysis. But the outcomes would not have differed much, if at all.

So why are we being told to put all, or most, of our money in stocks “for the long run” based on one study? One can conjure up two theories. First is that there is more money for everyone involved in managing stocks than there is in managing bonds or cash. And, aside from that handful of honest, sharp advisors (several of whom I know personally and/or deal with much to everyone’s satisfaction), most people in the “financial advisory profession” are motivated primarily, if not exclusively, by self-interest. There’s nothing wrong with self-interest, but there is something wrong with exclusive self-interest, especially if not disclosed.

Second, most “financial advisors” (again, aside from those handful who still dignify their profession by their conduct and diligence, several of whom are friends and/or business associates of yours truly) are either not all that bright or, if they are bright, that brightness manifests itself in sales, rather than financial, skills. Thus, they simply repeat back what is spoon fed to them by their higher-ups, the people who supposedly know what they are doing. Hmm….

I’m not saying that some of your money, and some of just about everyone’s money, should not be in stocks. Stocks have historically (as long as history is long enough) provided attractive returns and certainly hold potential for outsized positive returns. But don’t let anyone talk you into putting everything, or nearly everything, into stocks and waiting for the long run to transpire.

But if you’ve been in stocks for the last few years, you already know that.

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