Written by Mark Hulbert
Needless to say, stocks are much riskier than most people realize, and there are no guarantees.
Investors are learning the wrong lesson from Japan's Nikkei 225 stock average, JP:NIK, which topped its 1989 high last week.
Many investment experts argue that this proves that if you hold a stock long enough, it will eventually pay off. In fact, the true lesson from Japan's experience is that stocks are much riskier than most assume, and there are no guarantees.
Most investors completely ignore Japan when concluding that stocks should dominate over investment horizons as short as 10 years. There is a belief that Japan's decades-long drought is an exception.
But that's not the case. As you can see from this graph, in addition to Japan, seven countries have had a 30-year total stock market return below the inflation rate at some point in their history over a century.
An exceptional American experience
Some investment professionals react with what I call American exceptionalism, the idea that the United States is inherently different and therefore unaffected by historical precedents in other countries.
But the U.S. has a unique experience of not increasing stock prices for years, let alone decades. According to Edward McCurry, professor emeritus at Santa Clara University's Leavey School of Business in California, over the 75 years of U.S. history from 1909 to 1984, the S&P 500 SPX, adjusted for inflation, was: It has become. The end was not higher than the beginning.
So even if you believe in American exceptionalism, you should consider the possibility that the S&P 500 index, based solely on end-of-the-century prices, may not be any higher than it is today, adjusted for inflation.
Where is the risk?
Either way, there are theoretical reasons to doubt investors' blind faith in the argument that stocks will always win if you hold on long enough, McCurry told me in an interview. Of course, according to that argument, stocks provide long-term returns to compensate for their risk. But if stocks always pay off in the long run, as McCurry asks, where is the risk?
It can't have both meanings, he says. On the other hand, if a stock you hold for a long time is indeed risky, it means that you may incur losses over the long term. On the other hand, stocks have much lower long-term risk if you deny the possibility of long-term losses. In that case, from a theoretical perspective, the expected return should be much lower. In the same way.
Reduce investment risk with a combination of stock and Treasury inflation-protected securities.
As Japan's experience teaches us, holding stocks for the long term remains risky. Consider a simulation run by London Business School finance professors Elroy Dimson, Paul Marsh, and Mike Stanton. Given a stock's average historical return and the standard deviation of that return, we find that the stock market has a significant chance of incurring losses over very long holding periods. For example, one simulation calculated that the probability of an inflation-adjusted loss over a 40-year investment period is 15%.
Tips for rescue
One investment option that is available today but did not exist for most of the history of the U.S. market is TIPS (U.S. Government Treasury Inflation Protected Securities). For example, the yield on 30-year TIPS is currently 2.19% above the inflation rate. This means you can secure a real return of more than 2% over the next 30 years.
Granted, you have to keep your money tied up for 30 years to get that benefit. But as I explained in a column last November, much the same thing can be done by building a ladder of individual His TIPS that matures each year over the next 30 years. Alan Ross, founder of investment advisory firm Wealth Logic, said in an email that the currently established 30-year TIPS ladder can support a 30-year guaranteed withdrawal rate of 4.62%, adjusted for inflation. (Of course, this withdrawal rate represents a combination of principal and interest returns; Ross says the ladder's internal rate of return is 2.1% per year.)
You don't have to invest your entire retirement portfolio in a TIPS ladder to take advantage of this opportunity. A conservative approach may be a combination of stocks and his TIPS ladder. If stocks do as well as they have at times in the past, the stocks portion of the portfolio will be even larger in 30 years when the TIPS ladder is exhausted. Even if the stock price isn't that great, you'll still be well cushioned from the brunt of your losses.
Mark Hulbert is a regular MarketWatch contributor. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. Contact him at mark@hulbertrateds.com.
Read more: Japanese stocks hit new highs in 34 years – but markets in these countries haven't seen new highs in 15-20 years
-Mark Hulbert
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03/02/24 1201ET
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