Stocks Average Return
Stocks Average Return
Ten Stock Market Myths
(Source: The Wall Street Journal)
In tumultuous economic times such as these, your broker or financial adviser usually offers calming words of wisdom and advice. Stay in the market long enough and you will hear these many times. How true are these words of comfort? Let’s examine 10 of the most common and see how they hold up.
1. This is actually a good time to invest in the stock market.” Oh, really? Ask your broker if he’s everwarned a client that it was a bad time to buy stocks. Did he or she do this in October 2007? Maybe it was in February 2000, then? Even a broken watch has the right time twice a day, but no one wears one. Asking a broker if it’s a good time to invest in the stock market is like asking a barber if you need a haircut.
2. “Stocks, on average, make you about 10% a year.” This claim is based on past history, stretching back to the 1800′s. About three of the claimed 10% is from inflation. Stock market data from the 19th century has been shown to be unreliable. Twentieth Century data is complex due to World Wars and globalization. Remember, stocks only produce average returns when you buy them at average prices. If you buy stocks when they’re expensive, your returns are less than average.
3. “Our economists are forecasting…” Ask your broker if his economists accurately predicted the most recent recession. If they did, when did they make their predictions and which of his clients did your broker warn? What they usually predict is a slow-down, not a recession. That’s like a weather forecaster that predicts a 50% chance of rain; no matter what happens, their prediction will be correct.
4. “Investing in stocks lets you participate in the growth of the economy.” In 1969 the U.S. Gross Domestic Product was about $1 trillion and the Dow Jones Industrial Average was at about 1,000. In 1982, the U.S. economy had grown to $3.3 trillion. Where was the Dow in 1982? At about 1,000.
5. “If you want to earn higher returns, you have to take more risk.” The only way to earn higher returns is to buy stocks cheap in relation to their future cash flows. Your broker probably thinks that “risk” means “volatility.” Volatility usually means price ups and downs. Risk means the possibility of losing your principal.
6. “The market’s really cheap right now. The P/E is only about _ _ _%.” The price/earnings (PE) ratio, compares share prices to annual after-tax earnings. This index is misleading because earnings are so volatile; they are elevated in a boom and depressed in a bust. There are better measurements of stock expense. Try Dividend Yield, the cyclically adjusted PE or “Tobin’s q.” Right now, these metrics say that the stock market’s pretty expensive.
7. “You can’t time the market.” It’s certainly true that no one can catch the market’s twists and turns. But brokers use this phrase to keep their investors from pulling out their cash as the market is tumbling. The bottom line; if you invest when stocks are cheap, you will usually make money. If you buy when stocks are expensive, you will usually lose money. It sounds simple, but it’s true.
8. “We recommend a diversified portfolio of mutual funds.” If your broker means mutual funds with different names and “styles” such as: large-cap value, small-cap growth, mid-cap blend, etc; then this is just a marketing ploy. These funds are typically 100% invested, in stocks, all the time. Even “international” funds offer less diversification these days because the global economy has tied so many things together.
9. “This is a stock picker’s market.” If it is a stock picker’s market, what makes you think that you, or your broker, is the right person to do the picking? The vast majority of portfolio managers notoriously under performthe market.
10. “Stocks outperform over the long term.” I guess than depends on what you define as “the long term.” The economist John Maynard Keynes is famously quoted as saying, “In the long run, we are all dead.”
Are you tired of hearing the same stale lines from your broker?
The Truth About… Average Stock Market Returns
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