Stock Market Investing: The Greatest Wealth-Creating Machine of All Time
by Alexander Green, Chairman, Investment U; Investment Director, The Oxford Club
Friday, November 16, 2007: Issue #732
I received a note from a reader asking why we spend so much time talking about stocks. “Why not talk about other types of investments?” he asked. “Especially since the stock market is acting so badly.”
We do discuss other investment alternatives here, of course. We have devoted recent columns to commodities, junk bonds, real estate, precious metals, collectibles, currencies and inflation-adjusted Treasuries.
But our main focus will always be about stock market investing. Why?
Because nothing has performed better than equities over the long haul. Not cash, not bonds, not real estate, not gold, not collectibles, nothing.
Stock Market Investing: Take the Long View… It’s Worth Millions
Dr. Jeremy Siegel, a professor of finance at The Wharton School of the University of Pennsylvania, has done a thorough historical study of the returns of different types of assets over the past 200 years.
Here’s what he found:
- $1 invested in gold 200 years ago is worth $28 today. (That’s slightly better than inflation.)
- But the same dollar invested in T-Bills is worth $4,455. Better.
- $1 invested in bonds with interest reinvested is worth $13,975. Better still.
- And $1 invested in common stocks with dividends reinvested – drum roll, please – is worth over $8.8 million!
Now the odds are good you weren’t around 200 years ago. And, unless something truly exciting happens in the world of cryogenics, you won’t be around 200 years from now, either.
It doesn’t matter. The key is that over rolling periods of 25 years or more, investment returns for different asset classes are remarkably consistent.
Over the last 90 years, for example:
- 30-day T-bills have returned an average of 3.8%.
- 20-year Treasuries have returned 5.3% over the period.
- Large company stocks, however, have returned 11%.
- Small company stocks have returned 12%.
But while asset returns have been stable, human life spans have changed dramatically.
At the beginning of the twentieth century, the average American lifespan was 41 years. Today it is 77 years. And doctors say that if you live to 65, there is a very good chance you’ll make it to 90.
What does this have to do with stocks? Everything…
Make Your Money Last Longer With The Stock Market
If you’re in good health, you may live a lot longer than you think. And that means unless you’re already financially independent – and can live happily ever after with your money tucked away in tax-free bonds – stock market investing is going to play an important part in your retirement planning. The whole point of financial planning is to find a way to make sure your investment portfolio doesn’t kick the bucket before you do.
Unfortunately, this thought scares the bejesus out of novice investors – and a few old hands as well. Who can blame them when the typical stock market nest egg has been gyrating like an Egyptian belly dancer lately?
Relax. This is the norm. The previous five years without so much as a 10% correction in the market is the exception.
Investors who expect to earn the generous returns only a diversified stock portfolio can deliver while watching their net worth rise as smoothly as a bank balance are kidding themselves. That’s not how the world works.
Stock Market Investing – The Essence of Captalism
The way it works is this:
- Capitalism creates more prosperity than any competing economic system.
- The essence of capitalism is the private ownership of the means of production.
- And the stock market is the true democratization of capitalism.
Even people of modest means can own a stake in a profitable business by simply buying a few shares. With just a small outlay, they can even reduce their risk by owning shares in several businesses or in a mutual fund.
Pick up a few shares of Microsoft and your return will be the same as Bill Gates’ in the year ahead. Pick up a couple shares of Berkshire Hathaway and your investment will compound at the same rate as Warren Buffett’s.
How quickly this notion gets lost in today’s financial media, where the focus is constantly shifting from Fed policy to Wall Street downgrades to advance/decline ratios. Yes, the stock market can be frightening at times. But nothing offers you the prospect of earning higher long-term returns.
For that reason alone, our focus here at Investment U will rarely stray too far from the greatest wealth-creating machine of all time: stock market investing.
Good investing,
Alex
Today’s Investment U Crib Sheet
What’s the difference between “common” and “preferred” stock? It all comes down to who gets first crack at the company’s earnings and assets…
- Bondholders are actually the first to get paid, in the form of interest and repayment.
- Those holding Preferred Stock are next in line. In general, preferred shares pay a fixed dividend and participate in capital appreciation. But there’s a catch: When you buy preferred shares, you trade your voting rights in for the special dividend treatment.
- Investors in Common Stock, however, do get voting rights. And they enjoy the capital appreciation, as well.
Another way of looking at it: If a company’s liquidated, its bondholders are the first to get their money back. Preferred shareholders are next in line. And anyone holding common stock gets whatever’s left over.
So the next time you analyze a company’s balance sheet, take a look at how many preferred shares they’ve issued. Technically, these are a liability.
- Bond Market’s Glimpse Into 2009
- Buy “Low-Density” … How to Take the Guesswork Out of Valuing Stocks
- The Ultimate Inflation Hedge: Stocks?
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