What better way to start writing again (Happy October!) then to write about an investing fallacy: over periods of 20 years or longer, many investors automatically assume that stocks are the best investment. Really, it isn’t fair. Stocks have behaved (before this decade anyway) in such a controlled fashion, gaining 10% or so on average every year, that it is only natural for many investors to assume that this trend will continue. Well, as Jason Zweig of the Wall Street Journal makes clear, that isn’t the case.
Holding Risk
No, investing in stocks isn’t quite that easy. With time comes new dangers and considerations. Inflation is a constant concern. You get closer to retirement. The fundamentals of the stock change (and not always for the better). The biggest danger, however, is a big bear market.
As Zweig points out, while investing in stocks and holding them for longer time periods increases you chance of gains, it also increases you chance of experiencing a bear market. This decade, boasting both a technology and a housing bubble, certainly proves that statement. The biggest problem isn’t experiencing the bear; bear markets are an opportunity to load up on stocks which were formerly overvalued. The biggest problem is retiring in a bear market, or having one hit immediately after retirement.
Why Do Stocks Increase in Price?
Fundamentally, a share in a company is the right to some future profit earned by that company. This makes the stock market inherently speculative. The problem with recent (read: pre 2001) history is the lack of risk apparent in the stock market. When risk isn’t a factor, stocks increase to wild valuations. Of course, this in turn brings back the risk that any deflation of wild hope will also deflate the market. This can be seen in many growth stocks; when a growth stock misses earnings expectations by a penny it often takes a harder hit than a so called ‘value‘ stock.
The sentiments in the article from Warren Buffet convey the right idea. The important thing about stocks, bonds, or other investments isn’t asset class or holding period. It isn’t even the price at the end of 20 years (or any other holding period). The important thing is the price that you get into the security with. Happy investing!
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