Stocks, we have been told again and again through the years, are the best long-term investment. Prices go up and they go down, but give stocks enough time and they deliver returns that trounce those of bonds, real estate, commodities or any other asset class.
Ha! you say. Have you checked your 401(k) balance lately? Since the beginning of this decade, the stock market has been a money pit. At the market's nadir in early March, stock investors had lost more than 50% since March 2000, if you factored in inflation. Things have improved since then--to a mere 40% loss.
So can stocks possibly still be the best long-run investment? Somewhat surprisingly, the answer turns out to hinge on what you mean by best and what you mean by long-run. The investment part actually remains pretty cut and dried. Over the past two centuries, stocks have done dramatically better for investors than have bonds or any other asset class. And while, to parrot the mutual-fund prospectuses, past performance is no guarantee of future results, there are sensible economic arguments why stocks should continue to perform best in the future.
But that does not mean that buying and holding a portfolio composed mostly of stocks--the standard investing advice of the past quarter-century--makes sense for all of us. In the past few years, the mantra of "stocks for the long run" has come under fire from some respected students of financial markets. Their two main critiques have to do with those terms long run and best. The first debate centers on whether you can count on stocks' long-term advantage to work out over your particular investment horizon; the second is about whether an investment as risky as stocks belongs in a retirement portfolio in the first place.
The Case for Stocks
First, though, a little background on stocks for the long run. The notion goes back to 1922, when a bond brokerage in New York City hired Edgar Lawrence Smith to put together a pamphlet explaining why bonds--and certainly not stocks--were the best long-term investment. At the time, this was conventional wisdom on Wall Street. Bonds were for investment, stocks for speculation--and, in those pre-SEC days, for manipulation. But when he investigated the historical record, Smith recounted later, "supporting evidence for this thesis could not be found." Instead, he discovered that over every 20-year span he examined but one, stocks handily beat bonds.
In 1924, Smith published the results as a book called Common Stocks as Long Term Investments. It was a sensation. Smith--a businessman of no great distinction up to that point--launched a mutual-fund company on the strength of his sudden fame and got an invite from John Maynard Keynes to join the Royal Economic Society. His argument was that stocks would continue to beat bonds because they a) were less vulnerable to having their value eaten away by inflation and b) allowed investors to share in the growth of the U.S. economy in a way that bonds and other assets did not. These two tenets were the indispensable theoretical underpinning of the 1920s bull market.