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What is the truth about investing?

 

By Randy Neumann

Most of the change we think we see in life is due to truths being in and out of favor. – Robert Frost

Go back nine years to a time when the stock market bubble was at its height. A few cautious advisors warned of “overvalued, unprecedented returns” and cautioned “value does matter.” Allan Greenspan, then head of the Fed, muttered something about “irrational exuberance.” Yet, from others, including many investment professionals, we heard, “Everything is different this time.”

As we learned the hard way when the bubble burst, everything was not different this time. I’m here to tell you that the basics of investing were, are, and will always be the same. The only difference between the past and the present is that investing is now an entertainment medium carried by cable networks. All day, and sometimes well into the night, we see talking heads sitting under hot klieg lights telling us why this or that happened in the market. How ludicrous. Do these people think that they know why the markets did this or that? No, but it sells mouthwash and airline tickets. The guy who had it right 90 years ago was famed financier John Pierpont Morgan. After a tumultuous day in the stock market, he was asked by a reporter, “What will happen in the market tomorrow?”

His response was a terse, “Tomorrow, the market will fluctuate.”

Over the past few years, some new “truths” have materialized. Perhaps the most antithetical was “Everything is different this time.”

Let’s take a look at history. In the past 75 years, the stock market has fluctuated (as JP Morgan said it would). During this time period, the best single year performance came in at plus 55 percent; the worst was a minus 45 percent. In the same time frame, the market was down in 21 different years, which is 28 percent of the time. The question then becomes, “Why would anyone invest in an asset which is down almost 1/3 of the time?” The answer is, “for the overall return potential.”

In the securities markets there are three primary ways to invest: cash, bonds, and stock. Since 1925, Treasury Bills have averaged an annual return of 3.6 percent. Longterm government bonds averaged 5.1 percent, and the S&P 500 (the stock of America’s largest 500 companies) earned 11.1 percent a year on average. The markets are beautifully and brutally efficient. Stock investors expect a premium compared to cash and bond investors because of the risk that they take. These returns are based on indices and would not be able to be invested into directly. (Past performance of an investment(s) is no assurance of a future result. Investments in securities markets involve risks such as loss of principal.)

So, let’s talk of the risk in the stock market. One of the risks is of time. All stocks may lose value. The risk is one of time. It was mentioned above that using annual returns showed the stock market to be a loser almost 1/3 of the time. However, investors are not concerned with the short run. Savers, e.g., those saving for a down payment on a house or a car, should be concerned with short-term fluctuations and, therefore, should have their savings in cash accounts like CDs and money markets. Investors, e.g., those saving college tuition for young children or for their retirement, must look to the long-term potential.

Looking at the results of the stock market in a midterm view shows that by using 5-year rolling periods, e.g., 1925-1929, 1926-1930, etc., the market was down in 8 of 70 periods. If we increase our time horizon to 10 years, the market was down three periods, two of which were during the Great Depression, the last being 2000-2009. Stocks are a necessary part of most portfolios. They have the highest average return (11 percent) of the three basic investments, but that doesn’t mean that they will earn 1 percent per month. Remember what JP Morgan said: they will fluctuate (and potentially lose value).

Another factoid that has been spewed about recently is that there is a “new economy.” This is true; it began in the 10th century. What’s going on now is just an extension of what’s been going on since then. Technology, by definition, means something new. There is always something new. There was a time when computers were something new. There was a time when automobiles were something new. There was a time when the cotton gin was something new. In the 10th century, individual ownership of land was something new, and that’s what really started the big changes.

Ultimately, the economy itself does not change. It is how wealth is distributed that changes. To argue that somehow this time is different is an old adage and is also the most dangerous phrase ever spoken in the investment community. Things seldom change. Everything that is old is new again. Don’t be fooled by anyone telling you different.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for the individual. Randy Neumann, CFP® is a registered representative with and securities and insurance offered through LPL Financial. Member FINRA/SIPC. He can be reached at 600 East Crescent Avenue, Suite 104, Upper Saddle River, NJ 07458, 201-291-9000.

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