Deciding If Stocks Truly Are A Good Investment Long Term

Good Investment

In today’s financial markets, the debate on whether equities is always the best investment for the long term is one that is controversial. It is the message typically sold to less savvy investors but the reality is the idea is mostly based on theory. The assumption is that since stocks are riskier than say government bonds, the return for that perceived probability is a higher return on investment. This is many times referred to as the equity risk premium, and in practice doesn’t always correlate with reality.

This is so because the basis of this idea was based on data available to American based investment advisers, who primarily invested mainly in their own country’s investment vehicles during that time. The American economy of the twentieth century proved to be very lucrative but the results are more of an outlier when compared to historical data throughout the world. Also, historical events easily could have changed the outcome . A good example of this would be when an investor in the early 1900 may have chosen to place their bets on Germany as it was a rising superpower. Hyperinflation of the 1920’s and World War 2 would have turned what seemed like a good investment into a major loss. Basically, no one can predict the outcome of an investment reliably and only through hindsight can they make statements about the viability of equities.Stock market bull bear

Three gentleman from the London Business School, named Elroy Dimson, Paul Marsh and Mike Staunton are the renowned experts in the field of global investments as they have rigorously compiled investment data for over a hundred years, spanning all across the globe and covering over 20 plus countries. This data reveals that the longest period of negative returns from US equities as a whole was at most 16 years. Compare this to the global average of 19 and one can see how equities reputation as a good long term investment is a bit skewed. Examining individual economies further reveal a dire situation in global equity investments, with some countries experiencing negative returns straight for 66 years such as France. This would be way more than any reasonable investor could tolerate.

If that wasn’t convincing enough to warrant further research, another way to look at it is from the perspective of other investment vehicles. Inspect something safer such as bonds and compare the overall return versus equities and see if the promise of the risk premium is truly delivered. Available charts depicting this will reveal that long dated government bonds with a maturity of at least 10 years still are winning over equities for similar time periods, even when factoring the equity surge of 2009.Good Investment

In the U.S. in 2011, equities clearly had lagged behind Treasury bonds so even with a historically stronger economy, the evidence is pretty compelling. Many will argue that what is mentioned here is due to cherry picking starting points and not properly extrapolating future returns. We’ve already covered that no one can really know the future so taking such a long view and arguing that equities are the best available asset for the long term is an absolute statement, with no accounting for the many variables that could effect the outcome.

Once one comes to the conclusion that equities do have a chance of under performing, even when factoring in extended time for favorable adjustments, then one can focus properly on starting valuations. Ironically, if valuations are high, the more chances of the return on investment being lower than expected. Think of it as if the anticipation of something being successful is all but assured, the valuations would be pushed higher to reflect this. This dramatically decreases the likelihood of any decent return from ever happening. This is where the danger lies since assumed returns for US public sector pensions of around 7 – 8 percent forces allocation of large stakes in equity positions, exposing them to much higher risk. As one can see, equities, while good investments still need to be properly analyzed before including them in one’s portfolio.