Tuesday, June 29, 2010

A dirty little secret about the stock market

Wow. Now here's something that will blow your mind if you believe stocks are the best place to invest your money:

The last 30 years, it should be pointed out, had possibly the largest bull market run for the stock market in history. Yet Charles Allmon was never more than 50% in stocks; most of the time he had less than 25% of his portfolio in stock. And only a few stable, high-dividend stocks at that. Turns out that over the last 30 years, a time frame in which stocks have done exceptionally well by historical standards, you could have done just about as well parking your money in safe money market accounts.

Of course, most financial advisors will tell you stocks are the best investment in the long run. I'm sure the fact that stocks are most profitable for these financial advisors has a little something to do with that. Of course, it should be noted that yes, historically stocks have done quite well relative to other investments. But, as Paul Krugman noted in an essay in The Economists Voice, that probably just means that historically stocks have been under-priced. By historic standards, stocks are priced very high today, indicating those rich returns of the past may not be the reality anytime in the near future. Look at it this way, the market has a choice of different investment vehicles. If one vehicle consistently outperforms the others, the market will recognize that and bid up the price until the performance matches the price. If history is any indication, investors will bid up the price beyond the point it's a good deal, thus rendering the asset to be an inferior choice even though historically it was a better choice.

Given the phenomenal performance of stocks in the 80's and 90's, and the subsequent abysmal performance, I think we're just seeing the reversion to the mean for stocks. This process will probably play out for quite some time before stocks become a superior asset class again.


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