If you can reach it, pat yourself on the back. A new study shows that American investors have, for the most part, acted calmly and sensibly in the face of some of the worst provocations in financial history. It hasn't been easy.
There's been a torrent of disturbing news since the new millennium began -- ample excuse to bail out of stocks: A presidential election decided in the Supreme Court. A high-tech stock crash and bear market that led the benchmark Standard & Poor's 500-stock index to fall three years straight for the first time since 1941. The 9/11 terrorist attacks that killed 3,000 innocent Americans and led to war in Afghanistan and Iraq. The revelations that Enron and other top companies had flat-out lied about their finances. The first recession in a decade. An unprecedented scandal involving mutual funds that gave special deals to big customers at the expense of small ones. And did I mention record-high oil prices?
That's the bad news. The good news is that, despite the horrors of recent years, you've stuck to your guns and stuck with stocks.
Risk and reward
Because this is my first column for Kiplinger's Personal Finance, I want to summarize my investment philosophy and explain why your fortitude is so important. The longer you can wait before cashing in, the more stocks you should own. If retirement is 20 years away, put nearly all your money into stocks. If you're saving for the imminent purchase of a house, then own bonds. History shows that stocks return far more than bonds in the average year, although in the short term, stocks are far more volatile. Long term, however, U.S. stocks produce very consistent returns, mainly because the U.S. economy produces very consistent growth.
Ibbotson Associates, the Chicago research firm, calculates that between 1926 and 2003, the S&P 500 returned an annualized 10.4%, including dividends. The annualized return for long-term Treasury bonds over the same period? 5.4%. After inflation, stocks have returned 7.4% annually; bonds, 2.4%. If the future is like the past, the purchasing power of an investment in bonds will roughly double in 30 years, but an investment in stocks will increase by a factor of eight.
But owning stocks for the short term (less than five years) is foolish. The Ibbotson data show that the S&P lost money 23 of the past 78 years -- roughly one year in every three or four. But now look at every overlapping ten-year period since 1926 (1926-35, 1927-36 and so on). Out of 69 such periods, the S&P has lost money only twice, and the last time was during the Great Depression.
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