Looking for My Return

I was certainly always taught that if you buy stocks and hold them for the long run, that's going to ourperform other investments. But via Ezra Klein, The Wall Street Journal points out that this hasn't held up recently:

The stock market is trading right where it was nine years ago. Stocks, long touted as the best investment for the long term, have been one of the worst investments over the nine-year period, trounced even by lowly Treasury bonds.

You can see the chart to the left. Dean Baker wonders what would happen if instead of Social Security benefits everybody retiring right now had just lost a bunch of money in the stock market. It's a good question. I suppose it's always also worth wondering amidst a downturn if the seemingly too-high risk premium that sticks have traditionally paid might just go away -- maybe the free ride is over.

Comments

seemingly too-high risk premium that sticks have traditionally paid,/i>

sticks?

do you even casually proofread?

Posted by MY strikes again | March 26, 2008 2:51 PM

Whatever you do, don't invest in sticks!! Those things are worse than CDOs.

Posted by blah | March 26, 2008 2:58 PM

A period of 9 years that begins in the midst of a huge bubble and ends in the midst of a recession does not constitute the "long term". Stocks are very profitable if you're looking at a period like 20-30 years, or if you're smart enough to buy at a low and sell at a high. People who put a lot of new money into the market in the late 90s were asking for trouble - if they started earlier or later profits would be much higher.

Posted by cgaros | March 26, 2008 3:00 PM

seemingly too-high risk premium that sticks have traditionally paid

Short branches, twigs, and switches. Go Long trunks, stumps, and bamboo.

-Jim Cramer

Posted by drjimcooper | March 26, 2008 3:00 PM

I don't understand why this is news. We've known there was a late-90s dot-com stock bubble since, well, the early 2000s.

Given that any Social Security recipients would have invested in the stock market over the last 35+ years, not made a one-time investment in 1999, I'm pretty sure they would have outperformed US treasuries by quite a bit.

Posted by right | March 26, 2008 3:01 PM

Nine years is not the long run -- in the 9 years from 1990-99 years, returns were ridiculously good. Average together, and you get relatively good long run returns.

Vanguard Total Stock Market Index Fund has returned 10.54% since it was started in 1992.
It's also returned 13.8% over the last 5 years.
That certainly blows treasuries away (or anything other than risky junk bonds)

Sure, when you start the analysis immediately before the huge deflation of the internet bubble in 2000-02, stock returns look bad. That's not a recent phenomena -- the problem is 7 years ago.

If you wanted to guess what will do better over the next nine years, stocks or real estate, which would you pick? I'm putting my money in stocks.

Posted by pj | March 26, 2008 3:05 PM

Matt wrote:

I was certainly always taught that if you buy stocks and hold them for the long run, that's going to ourperform other investments. But via Ezra Klein, The Wall Street Journal points out that this hasn't held up recently:

"long run"

"recently"

Note the contradiction here? The thesis that common stocks are the best investment for the long run has not been disproven because "the long run" has always meant, in the minds of responsible financial advisors, 25-35 years. There have been a number of periods in post-depression American when stocks have done badly over a several year period. There have been none where stocks have done badly over the time horizon that someone planning for retirement faces.

So to the question of Social Security. Yes, someone retiring now at age 65 would have had seen their wealth stay flat since they were 56, which represents under-performance vs. T-bills. But they would have seen their wealth over-perform T-bills by a very wide margin from the time from when they were 18 until the time they were 56 (in the aggregate). They would still likely come out ahead - far ahead.

Also (and forgive me for rambling, but this is a starlting stupid argument from Ezra) - you'll note from the graph that stocks have been doing well in the last few years, but the total 9 year period looks bad because, um, THE INTERNET BUBBLE BURST at the beginning of the period. Prior to this there was a huge run-up in stocks, which in retrospect was asset prices becoming irrationally inflated and then deflating post 1999.

Cherry pick your 9 year period and it looks horrible. Extend it to 12 or 15 years and its looks OK. Shorten it to 5 years and it looks OK.

Posted by sd | March 26, 2008 3:05 PM

Buy and hold is stupid.
Ever heard of dollar cost averaging? Yes, the chart looks terrible, but anyone can tell you it's idiotic to take a chunk of money and just drop it into securities all at once.
My 403(b) has gone up very nicely on a yearly basis even though the market is in essentially the same place.

Posted by mbuchel | March 26, 2008 3:05 PM

The article points out that when you invest in something at the very height of a bubble, it may take quite a while to regain your investment after the bubble pops.

Good point! I'm sure nobody ever thought of that before.

What I wonder is why Dean Baker thinks many people would have invested all their Social Security money in 1999 - and in no other year before or after 1999 - and then just retired in 2008. That seems pretty unlikely.

Posted by Al | March 26, 2008 3:09 PM

Everyone knows that over the long term, the annualized return on stocks is around 10%.

What they don't know is how we get to the 10%.

Four (4%) percent comes from Dividends. In the nineties and oughts the dividend rate came down to less than two percent (2%). Three percent comes from the effects of inflation. Over the long-term inflation is 3%-3.5%, since the nineties it's in the 2%-2.5% range. The final three percent comes from growth. The statistics on growth have been very high for the last six years, but....maybe equities were a little overpriced in the late 90s!

Last summer Barry Ritholtz linked to a graph that put this math together in a very nice way, but I'm not going to go look for it.

Posted by Stav | March 26, 2008 3:09 PM

Does this chart actually show what it appears to show? If you'd bought a stock 9 years ago, you'd be dead even, sure, but how would your portfolio look if you'd been buying continuously during that period? It looks like since 2004 or so, you'd have had the opportunity to buy a hell of a lot of cheap stock.

Posted by Egypt Steve | March 26, 2008 3:10 PM

Everyone knows that over the long term, the annualized return on stocks is around 10%.

What they don't know is how we get to the 10%.

Four (4%) percent comes from Dividends. In the nineties and oughts the dividend rate came down to less than two percent (2%). Three percent comes from the effects of inflation. Over the long-term inflation is 3%-3.5%, since the nineties it's in the 2%-2.5% range. The final three percent comes from growth. The statistics on growth have been very high for the last six years, but....maybe equities were a little overpriced in the late 90s!

Last summer Barry Ritholtz linked to a graph that put this math together in a very nice way, but I'm not going to go look for it.

Posted by Stav | March 26, 2008 3:12 PM

Does this chart actually show what it appears to show? If you'd bought a stock 9 years ago, you'd be dead even, sure, but how would your portfolio look if you'd been buying continuously during that period? It looks like since 2004 or so, you'd have had the opportunity to buy a hell of a lot of cheap stock.

Posted by Egypt Steve | March 26, 2008 3:13 PM

Of course stocks outperform Treasuries in the long run. Pretty much everything does. The point is that Treasuries are as close to risk-free as you can get. What do you do with the cohort of people who retire right after a crash wipes 20%-30% of their savings out? The government's going to have to bail them out one way or the other.

Posted by Ginger Yellow | March 26, 2008 3:16 PM

You're telling me... I lost about 18% last year alone, sigh.

Posted by socctty | March 26, 2008 3:17 PM

PIMCO's Bill Gross offers a readable explanation of anemic stock market returns here. The 2006 article deals mostly with the expectation of low future returns due to the end of disinflation and the decrease in market volatility, which paradoxically leads to over-leveraging, which in turn leads to increased vulnerability of financial markets, a thesis that seems to have been confirmed by recent events (ugh, I swear this sentence wasn't translated from German). Why this negative feedback loop of lower volatility, over-leverage, and vulnerability doesn't lead to a risk/return profile similar that of the past is a question Gross doesn't really address, but I'm sure there are impenetrable papers on the topic for those who enjoy stochastic finance.

Posted by Patrick | March 26, 2008 3:19 PM

Even if we only care about the 1999-2008 period, you could have done a lot better if you had also bought non-US equities. Why would you only buy American, given that our stock market is only about 40% of total world market cap.? That's stupid. If you're gonna diversify into the S&P 500, go all the way.

The point from Egypt Steve about dollar-cost averaging is also strong.

In short, Yglesias and Klein need to brush up if they ever hope to pass the CFA exam.

Posted by nbt | March 26, 2008 3:23 PM

This where twenty-somethings tend to lack historical perspective. Back in 1979, when your parents were grooving to Blondie on vinyl, after a similarly lackluster 9-year period for stocks, Business Week published it's famous issue lamenting The Death of Equities. Take a moment and pull up some charts of your favorite indexes or blue chip stocks going from 1979 until today

Posted by Fred | March 26, 2008 3:25 PM

Meanwhile, gold is up 224% in that same time period.. :)

Posted by fp | March 26, 2008 3:25 PM

1) 1966 to 1982. That's a long time fellers.
2) One of the major virtues of Social Security is precisely its separation from the market. You have a segment of your retirement income that is not market dependent. That's an extra asset diversification that helps; especially when the black swan shows up - ie now.

Buy low Sell hi Monitor your investments Reduce risk as you approach retirement.

Posted by Northern Observer | March 26, 2008 3:26 PM

I'm sure all these lectures about how "long term" means 25 to 35 years would be very comforting to all the people screaming for a bailout when their stock-invested Social Security funds plummet. The politicians can just give them a little economics talk and send them home happy.

Posted by KCinDC | March 26, 2008 3:30 PM

Ditto the kudos for Egypt Steve, and nbt. The CW is not "put all your money in sticks at once." The CW is diversify and dollar-cost average.

If you do that, sticks turn out to be just fine.

Plus, you can use them as kindling.

Posted by Ted | March 26, 2008 3:31 PM

On a tangential note: my investment broker likes to say to me, "You need to plan as if Social Security isn't going to be there." To which I respond, "Huh?? Why wouldn't it be?" And then he says, "You don't seriously think the politicians will save the system by the time you retire, do you?" To which I say, "Uh... actually yeah I do, why wouldn't they?"

I think he's mistaken, but that's what the professionals think (and want)!! Of course he has no power to influence politicians, but his boss's boss's boss's bosses surely do...

Posted by nbt | March 26, 2008 3:39 PM

Buy low Sell hi Monitor your investments Reduce risk as you approach retirement.

This is one of things that makes me want to smack someone. If I could buy low and sell high consistently, I'd be a billionaire. This is effectively a recommendation for attempting to time the market- not a good investment strategy.

On the other hand, reducing risk as you approach retirement is a good idea. Privatizing social security makes no sense b/c SS is not an investment in federal bonds, it is an investment in the American economy. Current obligations are paid out of current receipts. Thus, as the economy grows, so do your effective SS returns. And we get this without the risk premium in the stock market. If you suffer a negative 30% growth in the 10 years before you retire, that can be devastating to your 30 year return average. Thirty years is a shorter investment time horizon than you think.

Posted by mpowell | March 26, 2008 3:40 PM

above someone mentioned dividends and indeed the chart appears to missing dividends. I have a chart of the S&P 500 total return index (includes both cap appreciation and divs) that shows an annualized 5.06% since12/31/98. If someone can quickly tell me how to post a .gif file, I will post

Posted by mike c | March 26, 2008 3:44 PM

On a tangential note: my investment broker likes to say to me, "You need to plan as if Social Security isn't going to be there."

As Financial Advisor myself (and liberal) I absolutely hate this scare tactic. I think there are other ways to impress upon people the importance of saving for one's own retirement without encouraging irrational fears and/or hatred of the government. I am, however, most definitely in the minority in my profession both politically and on this point in particular.

Posted by drjimcooper | March 26, 2008 3:49 PM

The stock market is trading right where it was nine years ago. Stocks, long touted as the best investment for the long term, have been one of the worst investments over the nine-year period, trounced even by lowly Treasury bonds.

Um, also, if we are going look at whether it makes sense to allow people to invest Social Security in the market, we should be comparing the rate of return on the S&P to the rate of return on Social Security, not to "lowly Treasury Bonds". You don't get back in Social Security funds the a return equal to Treasury bond rates. It's much, much lower.

The appropriate comparison here would be between (a) a person who invested $10,000 in the S&P500 in 1999 and (b) a person who paid $10,000 in social security taxes in 1999. What can person (b) expect in return if he retires this year, and how does that compare to person (a)?

Posted by Al | March 26, 2008 3:58 PM

- The end point bias of any data is a big quantitative gotcha.
- Buy and Hold results are very different from dollar cost averaging. It matters when discussing any investment/program
- I'm prepared to wrestle mpowell into the ground as I think he is substantively wrong on the outcome of SS (but not the part about a bet on GDP). Fiscal policies and demographics, assuming their current path, will doom SS as we know it, hence the nbt broker chatter.

Posted by mike c | March 26, 2008 4:03 PM

Mpowell,

Social Security isn't "an investment in the American economy". It's a defined benefit pension program where the benefits are determined by a formula. That formula doesn't take into consideration the ratio of workers per retirees, which is why Social Security is currently on a fiscally unsustainable path.

Social Security is a great deal for the lowest-income workers, who get highly progressive benefits, for those who are disabled early in their careers, and for those who wouldn't have the discipline to save otherwise. But there are better deals out there for those who aren't poor and are willing to save. That's why, for example, local police forces where I live have opted out of Social Security in favor of their own alternative programs.

Posted by Fred | March 26, 2008 4:07 PM

al -- you can not make the comparison you are proposing because an individuals returns on social security investing depends on their income level. An individual with a low income gets a much larger return from investing in SS then an individual with a high income receive. It is a defined benefit program.

Mike at http://angrybear.blogspot.com/
you can see a chart comparing the returns with and without dividend reinvested. You have a valid point that the WSJ chart is without dividend reinvestments. with daily dividend reinvestment the market is at about its 2000 peak.

Posted by spencer | March 26, 2008 4:07 PM

What's wrong with saving as if SS won't be there? That's my philosophy and is not based on a feeling that SS will or won't be there.

I figure if SS is not there, I'll be fine. If it is there, I can blow it all on golf club memberships and expensive scotch.

Posted by mike | March 26, 2008 4:09 PM

I, too, have done nicely in the market since 2000 by just continuously dollar-cost-averaging into it and periodically moving profits into other asset classes. But I'm a firm believer in diversification as well, with a fairly conservative asset allocation that includes bonds, a fixed annuity, real estate, and (yes) social security. Oh, and Al--How the hell do you compute a "return" on social security? How much you get out of SS depends sorta critically on how long you live--a variable that I haven't the foggiest idea how to model [actuarial tables say nothing about individual cases]. The advantage to SS is that it will be there [yes, really!!] even if you outlive all your other money. I consider it an important part [not the whole] of a reasonable retirement portfolio.

Posted by David in Nashville | March 26, 2008 4:12 PM

Oh, and Al--How the hell do you compute a "return" on social security? How much you get out of SS depends sorta critically on how long you live--a variable that I haven't the foggiest idea how to model [actuarial tables say nothing about individual cases]. The advantage to SS is that it will be there [yes, really!!] even if you outlive all your other money. I consider it an important part [not the whole] of a reasonable retirement portfolio.

You can achieve the same effect by purchasing an annuity, of course. So you need to compare the amount you would be getting in SS to the amount you can obtain through purchasing an annuity with the value of the investment.

Posted by Al | March 26, 2008 4:19 PM

Mike - Sorry to sound like an economist, but the question of whether or not SS will be there a few decades from now should influence your optimal consumption path over time, no? You don't want to unnecessarily deprive yourself now based on a false belief (or a wrong probability estimate) that SS will be gone in the future. Due to human impatience, it would be surprising if scotch in the future is just as satisfying to you (from the perspective of 2008 Mike, who is doing the planning) as scotch today.

What if I told you that I had a Nostradamus-like vision last night that your house will burn down 20 years from now? You could start to save basically all of your income above a subsistence level, on the reasoning that "Well, if the house burns down with all my treasured possessions inside, I'm set. If not, well, I'll have survived on canned tuna for a while, but then I can enjoy lots of top-shelf scotch 20 years from now."

Posted by nbt | March 26, 2008 4:19 PM

Dollar-cost averaging does not increase your expected return. Hope I'm not raining on anyone's parade.

Posted by Barbar | March 26, 2008 4:26 PM

al -- you can not make the comparison you are proposing because an individuals returns on social security investing depends on their income level. An individual with a low income gets a much larger return from investing in SS then an individual with a high income receive. It is a defined benefit program.

But we can figure this out, no? The person contributed zero to SS for 34 of the 35 years that are used to compute the relevant average, so we can say that for those 34 years, the person's "covered earnings" were zero. For the 35th year in the average - the year in which $10,000 was contributed to SS - we calculate the income level necessary to contribute $10,000 to SS (including both the employer's portion and the employee's portion).

Posted by Al | March 26, 2008 4:27 PM

Al 4:19pm - You're right about the annuity for comparing the return of the market, but on the "investment" (pre-retirement) side of things, rather than looking at a one-time equity purchase in 1999, we need to look at a dollar-cost averaged series of equity purchases over 40 years. SS benefits are based on a long-term average of the individual's contributions; I'm not sure if we can tease out the marginal effect upon future SS benefits from your 1999 FICA taxes considered alone. (It depends on too much other stuff)

Posted by nbt | March 26, 2008 4:28 PM

Barbar 4:26 - Dollar-cost averaging does not increase your expected return. Hope I'm not raining on anyone's parade.

Yes, but looking back at the the 1999-2008 period, we know all the data. There's no "expectation" here. In this particular case, in hindsight, dollar-cost averaging would have increased your actual return. You're right that over the long haul (over multiple business cycles), dollar-cost averaging won't increase your expected return, but it will help to smooth out short-term bad periods like the one that the WSJ article cherry-picks.

I'm not a finance whiz, so I would appreciate it if people can correct any wrong statements that I make here.

Can we get a basketball post? I'm jacked for PHX v BOS tonight.

Posted by nbt | March 26, 2008 4:40 PM

Of course if you want to evaluate dollar-cost averaging, you need to compare it to something. How about, putting your money into the stock market at random? This strategy also thoroughly beats buying and holding since 1999.

Posted by Barbar | March 26, 2008 4:54 PM

"Dollar-cost averaging does not increase your expected return."

Whether it does or doesn't is moot: it's how most people invest. Most people don't invest a lump sum once every 9 years, they make IRA contributions every year and make 401(k), 403(b), or 457 contributions every two weeks. Take the simpler example of the annual IRA contributions. The graph above describes your returns if you made one IRA contribution in domestic stocks at the peak of the bubble in 1999 and did nothing since. Had you continued to make IRA contributions every year, your overall returns would be a lot higher. You would have been essentially averaging down with your annual IRA contributions at the end of the bear market years 2000, 2001, and 2002.

Posted by Fred | March 26, 2008 4:56 PM

A person who retires today and switches his portfolio from 100% stock to 0% stock is an idiot. That's not how it works. The portion of stock in a person's portfolio should go down as he gets older, so it shouldn't be 100% at retirement in the first place. And a retiree may live for 25 years or more, so he should keep some money in stocks to get the benefits of long-term economic growth. People who switch entirely to safer investments get hammered by inflation, which is a virtual certainty.

Posted by M.C. | March 26, 2008 5:20 PM

I've been wondering what the term "pointy-headed liberal" referred to.

Posted by jay Dwight | March 26, 2008 7:48 PM

John Bogle wrote a very good speech on projecting long term returns here: The Perils of Numeracy

some idle thoughts I had on long-term stock returns are here

The key principle is Keynes's (quoted by Bogle):
"It is dangerous to apply to the future inductive arguments based on past experience unless one can distinguish the broad reasons why past experience was what it was."

Posted by roublen | March 26, 2008 8:07 PM

Whether or not dollar cost averaging is financially better than other methods is debatable; my guess it's probably at best break even, and may be worse.

But why I do it is that it's psychologically better. It gives you 'discipline' by plugging in 100 dollars or whatever a month, regardless of circumstances, either external or internal. And, mentally, the swings in the market don't bother you so your not tempted to 'make a mistake,' e.g sell/buy too early/late. And you don't try to redouble you bets if you guess wrong in a Kramer-esque market timing strategy.

Posted by Kolohe | March 26, 2008 9:12 PM

"...what would happen if instead of Social Security benefits everybody retiring right now had just lost a bunch of money in the stock market."

Answer: they would drop to their knees and thank God that they did NOT have their retirement savings in Social Security.

The average return on LIFETIME savings via Social Security is ... 1.23%. (If you're a black male its negative.)

Besides, the larger point from the academic study that underpins the WSJ article is: that after periods of extraordinary gains, in order for total returns to return to the long-term mean, subsequent periods MUST then underperform. That is, if a 30 year period performs at the historical norm of about 10% average, and if one decade averages 20% and another averages 15%, then the third decade will need to lose 5% in order to have the whole period revert to 10%.

The chart pictured here displays the underperforming period (and even then - as many have noted here - makes unrealistic assumptions that do not mimic the manner that people actually invest money).

Posted by Jamesaust | March 27, 2008 12:42 AM

In half-hearted, semi-defense of Social Security: its original, and main, purpose was to reduce poverty among the elderly. That's why its benefits to low-income retirees are so generous. It is a crappy deal for middle- and upper-income workers though; the only reason they are yoked into Social Security is to attempt to maintain the program's political appeal as a universal entitlement.

Posted by Fred | March 27, 2008 1:27 AM

Matt, your data sample is biased to show the conclusion you are suggesting. If you're trying to point that the market can go through 10 year stretches where stocks do not go up in price, then well yes this is true. If you are trying to extrapolate this to suggest that stocks have not been a consistent long-term money winner or that they do not go up more than treasury bonds on average, then you are grossly misusing the available data.

Posted by Mike | March 27, 2008 1:49 AM

Matt, your data sample is biased to show the conclusion you are suggesting. If you're trying to point that the market can go through 10 year stretches where stocks do not go up in price, then well yes this is true. If you are trying to extrapolate this to suggest that stocks have not been a consistent long-term money winner or that they do not go up more than treasury bonds on average, then you are grossly misusing the available data.

Posted by Mike | March 27, 2008 1:52 AM

Shorter version of Keynes: Your results may vary.
Why?
People don't invest consistently. They buy high & sell low, chase the latest investment fad or hot stock/ fund, etc.
They don't invest over their lifespan. Not surprisingly, the avereage twenty-something isn't thinking of retirement.
They don't have the money to invest, or don't budget for it.
They are confused or intimidated by the multitude of investments, and as a result do nothing, or keep their money in low interest bearing accounts.

Of course the investment industry's purpose is making money for themselves first, and you second. The confusing multiplicity of funds for example, are more sales vehicles than investment vehicles (and often needlessly expensive).
You could do worse than to read John Bogle, who basically invented the index fund.
Any system should be simple to follow, lifelong in scope, and automatic. Government might subsidize investments for low income people. It's not that it couldn't be done, it's that it's too disruptive to special interests and ideologically unacceptable.
My two cents.

Posted by ronin | March 27, 2008 11:08 PM