Stocks for the long run is almost always a good idea, or is it?
It’s generally a good bet that being in stocks will provide inflation beating returns. A lot of papers have studied this phenomenon in the past and concluded that this. For example, Vanguard has looked at just the American stock market and determined that investing for any 20-year period in American history would have yielded positive stock returns. However, in just 1-3% of the time a 100% stock portfolio would not beat inflation. This idea is very common and new research suggests this is actually wrong, it maybe a far higher percentage chance than investors initially thought.
For this research we’ll take a quick look at the following paper, entitled: “Stocks for the long run? Evidence from a broad sample of developed markets.”
Investing in American stocks is an attractive option, but what if we adjust the data some:
Again, investing in stocks is a pretty attractive option for long term investors. The historical equity premium in the US is quite large. The conventional wisdom is that over a long enough time period stocks are safe to invest in and long-term loss realizations in the US have been non-existent. For example Fama and French estimated in 2018 that the probability of loss and a high probability of gain for investors with 20-30 year horizons. One issue with many studies in the past is that the historical data for the United States stock market is fairly short only about 100 years of data exist for the most commonly accessed data sets. Plus, one does not need to look very far for examples of real long term historical losses – only across the ocean to Japan which has seen a real realized loss from 1990 to 2019. A diversified investment in Japanese equities produced returns of -9% and -21% in real terms. The study in question looks at the developed world returns and attempts to minimize potential biases that are present with a strict look at American stock markets. The study uses 39 developed countries over long historical periods which collectively make up around 2,700 years of stock returns starting in 1841 and ending in 2019.
Results of the study:
The results of the study can be summarized with this one picture:
Using bootstrapping simulations to resample the returns over the periods from 1841 to 2019 the authors were able to significantly expand the samples considered in prior studies. It allowed the authors to combat survivor-ship. But overall, the results indicate that there is a 12% chance that a diversified investor with a 30-year investment horizon will lose relative to inflation as opposed to the 1-3% from prior, US based studies.
Their analysis concluded with three main findings:
- “Long term outcomes from diversified equity investments are highly uncertain. Based on the historical record of stock market performance in developed markets, the 5th percentile real payoff (measured in terms of local currency) from a $1.00 buy-and-hold investment over 30 years is $0.47, whereas the 95th percentile is $23.30. This evidence stands in contrast to the conventional view that mean reversion in equity returns makes equity investing relatively safe at long horizons.”
- “Catastrophic investment outcomes are common even with a 30-year horizon, as the 1st per-centile real payoff is $0.14 and the 10th percentile is just $0.85. An investor at age 35 saving for retirement, for example, only realizes one draw from the 30-year return distribution, and we estimate a 12.1% chance that this investor will lose relative to inflation.”
- “The empirical findings based on the historical record of stock market performance across dozens of developed markets are notably different from those based on the historical U.S. experience. Estimates that rely solely on U.S. data suggest that long-term real investment losses are rare. The contrast in results highlights the importance of guarding against survivor and easy data biases in assessing the distribution of distant payoffs and also has economically significant implications for optimal portfolio choice.”
In other words, before choosing a 100% stock allocation on your retirement portfolio, an investor should consider the long-term risks of doing so. Do you plan to eventually have other income streams, whether before or after retirement? Or are you solely relying upon your stocks as your retirement vehicle? If you are solely relying upon your own investments as your retirement consider the possibility that you have an 88% chance of beating inflation, but also consider the dangerous flip side of that probability of having inflation eat away at your returns. It’s why asset allocation is one of the first things we recommend you do before investing. However, if you’re trying to build wealth and want to invest, try using m1 finance (you’ll get an extra $10 dollars with the referral link) it’s a great platform for long term investing. And finally, if you’re looking for further ways to enhance returns check out our high risk and ultra-high risk newsletter.
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