Investing for the Long Term

The Power of Postponement

Although recent experience has been discouraging, compounding investment returns over many years yields truly amazing numbers. Consider how money grows in an IRA for a young person who leaves the money alone until retirement.

The maximum contribution to an IRA is $5,000 a year for someone under age 50 (the money must come from earned income although parents can replace the contribution). Take a 20-year-old who earned and saved enough to put $5,000 in an IRA. Let's invest that money in a broad index that gets 10 percent returns, the average of stocks over the last century. After 50 years, the account would be worth $587,000 (this doesn't factor in inflation).

If he waits ten years, until age 30, the total at retirement would be less than half, $226,000. At 40, it would be $87,000; at 50, $34,000 and at 60, the total grows to $13,000.

These are average figures and the results could differ significantly. But this shows three things: how long you invest - whether for yourself, your children or grandchildren - is critical; the benefits of tax deferral make a huge difference; and achieving the broad stock market returns has been a great goal.

Gloom and Doom

Is it a Good Time to Invest in the Stock Market?

We never know when to buy stocks. The future is always murky. There are always plenty of things to worry about. And yet we know that over the long term --- 10 – 15 – 20 years --- stocks have almost always done very well. Over the long term, there are few other ways to keep with up with inflation and to accumulate any wealth.

The public attitude toward stocks has soured recently because stocks have not done well. Since the recent high in late April, the broad U.S. stock market is down 14 percent with much of that coming in several spectacular and scary drops. The most recent decade was the worst for the stock market in at least 100 years – worse even than during the Great Depression of the 1930s.

The world economy has suffered through a prolonged global downturn; the worst since the 1973-74 global recession and possibly since the 1930s. Recently Nobel Laureate Paul Krugman, in his column in the New York Times, predicted that we may be in the early stages of the third prolonged global Depression of the last 150 years.

Should we be depressed? Should we avoid stocks? Should we put our investment dollars under  the mattress, buy gold, party because the end is near?

Such gloom may be warranted but we like to look on the bright side. We would agree that the global economy was on the precipice in September 2008. It’s possible that we could have a serious relapse into recession but the odds favor a subdued but durable recovery.

Based on U.S. history and lessons from around the world, it’s likely that high unemployment will persist for at least several years. Even so, the U.S. recovery seems to be well established and likely to persist. The sluggish nature of the recovery, perversely, is likely to extend its duration as happened during the 1990s. But lacking a crystal ball, we cannot discount a second dip recession or some other massive economic mishap.

Why then are we so sanguine about the long-term prospects for stocks? For twelve years, the Dow Jones Industrial Average has hovered around 10,000. In inflation adjusted terms, the Dow has suffered a serious decline. By historical standards this is a long time for the stock market to stagnate. Meanwhile, Gross Domestic Product – the source of profits and ultimately the bedrock of stock valuation – has climbed by more than 60 percent.

While we don’t know when the stock market will break out of its funk, we are confident that it will eventually. Only long-term investors, those with horizons of five years or more, should normally participate in the stock market and over the long-term we see little to suggest that stocks will depart from their historic upward trend. If we are eventually to return to that trend, the very bad period that we’ve been stuck in for so long, actually augurs well for the future. 

We consider a key to participating relatively safely in any stock market uptrend is to craft a broadly diversified global portfolio, which is a mainstay or our investment approach.