The index's weakness may surprise a generation of investors raised on the cult of 'stocks always go up'
Are you feeling lucky?
Wall Street tries not to mention this too often, but there is about a 25% chance that your U.S. stock-market index fund, including an S&P 500 SPX large-cap fund, will prove to be a poor investment or worse over the next 10 years.
And there is even about a 1 in 7 chance, or 14%, that it will prove to be a poor investment over the next 20 years.
Which is remarkable, especially for a generation of investors who have been raised on the cult of "stocks for the long run," "don't time the market" and "stocks always go up."
Being a "permabear" and sitting in cash while predicting disaster is a foolish strategy over the long term. Being a "permabull" and always betting on stocks is slightly better, because stocks go up more than they go down - but it still leaves a lot to be desired.
The biggest myth is that somehow it doesn't really matter when you buy stocks, because over time they will always produce spectacular returns.
To see the actual numbers, I used the long-term stock-market data compiled by Yale finance professor Robert Shiller, whose work on markets and valuations earned him the Nobel Prize in economics. I used monthly data going back 100 years, to 1926. Technically, Shiller has data on stock-market returns and inflation going back to the 1870s, but there are reasons to be skeptical about the value - or even the reliability - of such ancient financial history. One-hundred years of monthly returns, adjusted for inflation, seems a pretty good sample, especially in an era when venture capitalists and Wall Street frequently refer to 10 or 20 years as "long term."
To cut to the chase: All this permabull mantra about stocks for the long term, and "average" stock-market returns of 6% or 7% a year plus inflation, need enormous caveats.
Averages can hide a lot of detail - like when Bill Gates walks into a bar and the "average" net worth of the occupants suddenly jumps into the billions of dollars.
On a 10-year view, the difference between buying into the S&P 500 at the best time and buying into it at the worst time was worth an astonishing 25% per year. Someone who invested in the summer of 1949 and held on for 10 years earned a spectacular compound return of 18.8% a year plus inflation - the equivalent of turning $10,000 into $56,000 in constant, inflation-adjusted dollars.
But someone who invested in the S&P 500 in the early spring of 1999 and held on for 10 years ended up losing on average 6% per year in constant, inflation-adjusted dollars - the equivalent of turning $10,000 into around $5,500 in real terms. In other words, they lost nearly half their entire investment in real, purchasing-power terms, plus a decade of compound positive returns on which they had been relying.
By coincidence, the terminal value after 10 years for someone picking the absolute worst moment to invest was almost exactly one-tenth the terminal value for the person who picked the best moment.
The variations over 20 years were smaller, but still huge. Someone who invested in the index in the spring of 1980 and held on for 20 years would have turned $10,000 into $128,000 - again, measured in constant, inflation-adjusted dollars. That's an annualized return of inflation plus 13% or more per year. But someone who made the same investment in the spring of 1962 - or September 1929, for that matter - and waited 20 years effectively earned nothing at all; the average annual return was about 0.3% a year.
The past is no guarantee of the future, and maybe these past patterns won't repeat themselves. But Wall Street seems very keen to cite historical data to suit its own purpose.
None of this is supposed to be an argument in favor of being a permabear and sitting on the sidelines in cash. Being a permabear is even more foolish than being a permabull, because the stock market has gone up far more often than it has gone down, especially over time. But it does mean that the permabulls, too, are viewing the world through a distorted lens.
When I ranked S&P 500 10-year returns by decile, I came up with the following:
In other words, 10% of the time over the past 100 years, investors in the S&P 500 lost an average of 2.6% a year, adjusted for inflation, over a 10-year period. That's the equivalent of losing 23% of your purchasing power over the full decade. Another 10% of the time, they earned an average total return of 0.4% a year - before taxes and fees, incidentally.
When I ranked the 20-year returns by decile, I got this:
The worst-case scenario isn't as bad, but it's still pretty lousy: 1.6% a year, or less than 40% total over 20 years. And that's before taxes and fees, of course.
Right now, you can earn an all-but-guaranteed 3.1% a year plus inflation for up to 30 years through inflation-protected Treasury bonds, or TIPS. In the past 100 years, investors in the S&P 500 did worse during 24% of all 10-year periods, and 14% of all 20-year periods.
That doesn't mean TIPS are the answer - but it does mean U.S. stocks don't deliver as often as the permabulls like to pretend.
-Brett Arends
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