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Why Stocks Are for the LONG Term

By JLP | May 7, 2008

My company just sent out the performance numbers for all of the top indexes we follow; they do this each month to keep all of us in the know about how the market is performing. I was really surprised by what I saw.

I knew stocks were down year-to-date, but I didn’t realize by how much stocks have underperformed over the last 10 year period. The S&P 500 Index (large cap stock) has returned only 3.89%, and the Russell 3000 Index (total stock market) has returned 4.28% for the 10 years ending 4/30/08.

Of course that’s before taking any taxes or fees into account, meaning most people’s returns – even if they had their stocks sitting in a stock index fund from April 98 to April 08 – essentially were flat and certainly didn’t beat inflation.

What’s more, the Lehman US Aggregate Bond Index annualized a 5.96% return over the same period, outperforming both major US stock indexes.

Now of course if you’re only looking at the last 5 years of performance, stocks have performed rather well – 10.62% for S&P 500 and 11.40% for Russell 3000. Bonds were 4.37%. Then again over the last 1 year, both stock indexes have negative returns (-4.68% and -5.15% respectively) while bonds are up 6.86%.

We must keep in mind that stocks are down over the last 10 years mainly because 1998 was near the peak of the internet stock bubble, which promptly burst soon after. If we look at returns over longer periods such as 15 and 20 years, returns are solidly positive (I don’t have that data, or I would provide it).

The point is that investing in stocks is truly for the long term. People like to talk about the average 8-12% return over 5+ decades, but the truth is that stock market indexes do have long periods of negative and/or flat growth during their historically upward ascent. You might get lucky over a 3 or 5 year period, but the best thing to do is to invest in stocks only when your savings goals are truly long term.

But what exactly constitutes long term? If you are saving for a house or car or vacation or anything that you want to purchase within the next 10 years, you would be better off to invest in mid-term investments (bonds, 5-7 year time horizen) or CDs, savings accounts, or money market funds (1-4 year time horizen). If you’re shooting for something in the 8-10 year range, go ahead and bet on stocks if you like. But remember, it is a gamble.

More from Meg at The World of Wealth

Topics: Asset Allocation | 11 Comments »


11 Responses to “Why Stocks Are for the LONG Term”

  1. Sam Says:
    May 7th, 2008 at 10:23 am

    Thanks for the info.

  2. Jeremy Says:
    May 7th, 2008 at 11:04 am

    In absolute terms, yes, the indicies are not very exciting. But, out of curiosity, what would the real world returns look like for someone during the same time frame? What I mean, is most people didn’t make a lump sum investment in 1998, and have held it for 10 years. Most people invest small amounts over regular intervals, such as with their 401ks and such.

    So, given we’ve seen some significant ups and downs over the past 10 years, what effect did dollar cost averaging have on total returns over this period? Did it improve an investor’s returns, make no difference, or perform worse over this 10 year period?

    That would be an interesting spreadsheet for JLP to put together :)

  3. Jeremy Says:
    May 7th, 2008 at 11:17 am

    Also, just to clarify, if someone did buy an index fund 10 years ago and just held it, they actually would have done quite a bit better than breaking even, provided the dividends were reinvested (which is usually the case).

    So even though the value of the index such as the S&P may be not showing very good returns over the past 10 years, someone who was invested in say, VFINX and reinvested the dividends and such would actually be up around 60% over since 1998.

    It can be a bit misleading when looking at the raw numbers, since real world factors like this can illustrate that things are better off than what the numbers might otherwise show.

  4. Shaun Rosenberg Says:
    May 7th, 2008 at 6:03 pm

    I agree that stocks are for the long term, but I don’t agree that you should hold stocks forever. Anyone should be able to outperform the SPY every year by trading. Especially considering you can make money (instead of losing money) when stocks go down.

    http://www.stocks-simplified.com

  5. Brice Hogan Says:
    May 7th, 2008 at 6:47 pm

    I absolutely agree with this line of thinking. Stocks will always return a positive number over a long period of time. For 20 year periods since 1929 stocks have had positive returns in all 20 of those years.

    My investing hero warren buffet must be pretty smart because he has held stocks for a long time. Over that time he has been able to amass a fortune by holding to two very important concepts: 1 Hold for the long term. 2.Annualized compound returns. If he has done it it might be wise to listen.

  6. Meg Says:
    May 7th, 2008 at 10:02 pm

    Jeremy – good point about dollar cost averaging; I am not sure how to find or compile that data, but I might have to look into it! As for dividend reinvestment, I’m not sure if or how that’s taken into account on these performance charts; is it really not factored in at all? In that case an investor would have certainly done better than what’s reflected above.

    It’s hard to separate increases from adding more money vs increases from market gains when you’re investing money all the time. Plus since you don’t usually pay taxes directly from your investment account, many people never see how that lowers your actual return.

    Vanguard does a cool thing on its website; it shows on a line graph two trend lines: one for how much you’ve contributed and one for market value (you can look at this by account, by holding, or for your total investments).

    I actually have several index funds with Vanguard that I’ve regularly contributed to for years (more than 5 but less than 10). Those lines aren’t actually that far apart (yet)! Though my market value IS higher than what I’ve contributed so far; and hopefully those lines will grow ever farther apart.

  7. bob Says:
    May 8th, 2008 at 11:31 pm

    I’m sure that no one wants to hear from an ultra, ultra financial conservative, but here goes…

    Despite my missing the “average” return, I sleep pretty well, ‘cuz I have 0 dollars invested in other than I Bonds. At age 72, even a five year plan is too long.

    I buy into what George Soros has to say about the economy and (by implication) the stock market.

    We’re into a once in a lifetime “super bubble” which includes all of the words you’ve heard in the past year…
    SIV CDO Credit Derivatives Housing Bubble Commodity Oil Ethanol Fiat Money Hedge Fund Inflation etc etc…..

    There just isn’t any “new bubble” to fill in for the huge deficit. Despite Mr. Bernancke’s jawboning, there isn’t any way out. The banks and brokerages will eventually have to “mark to market” all those mysterious acronyms that they are holding.

    Can anyone explain a $537 Trillion derivative notional value???

    Sooooo…. while I know I’m gonna go down the drain with hyperinflation, at least it won’t be because I’m watching and worrying that my investments will do worse than the inflationary percent.

    As Mr Soros implies… we may have to throw out investment history, when we’re dealt with the storm of the century.

  8. Dave2 Says:
    May 9th, 2008 at 9:27 am

    You can check S&P500 return, both adjusted and unadjusted for inflation, and both with and without dividend reinvestment at

    http://politicalcalculations.blogspot.com/2006/12/sp-500-at-your-fingertips.html

    As far as the “super bubble” theory mentioned above, note that the S&P is currently trading at about its historical P/E ratio, and dividend yield is also in line with historical levels. That was not the case during the “internet bubble” of the late 90’s.

  9. Bozo Says:
    May 13th, 2008 at 7:46 am

    Written in August of 2005, this article is must reading for anyone long in the stock market:

    http://www.zealllc.com/2005/longwave2.htm

    The author’s thesis, backed by statistics and historical analysis, is that we are currently (and will be) in a secular bear market until 2017 (from the tippy-top in 2000). We may have cyclical (shorter-term) bull and bear markets within that period (as we have seen), but the odds are another great bull (as from 1982 – 2000) won’t be here until, you read it correctly, 2017.

    Long term means, LONG term, folks.

    Yours,

    Bozo

  10. Invest in stocks Says:
    May 21st, 2008 at 4:02 am

    The risk of losing money in the stock market cannot be eliminated; it can however be minimized. Which is the best time to buy stocks? Always invest in stocks when the market price is less than the intrinsic value of a stock.

  11. Model dlya sborki Says:
    August 2nd, 2008 at 12:44 pm

    It is really inspiration and calming in these turbulent times.

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