Stocks: Long-term, consistent returns
Joel Dresang: Dave, on one of our weekly podcasts recently, you were part of a discussion about the long-term performance of stocks. It turns out that on your desk you have some research that shows how stocks have done since 1802. Why is that so important?
Dave Sandstrom: Joel, it serves as a really good reminder about the consistency of stocks over long periods of time.
Joel: What does that research show?
Dave: Well, economists like to break that time frame into three sub-periods.
The first, from 1802 to 1870, when the U.S. economy was largely an agricultural economy. During that time, stocks averaged 6.7% on an annualized basis.
Then, from 1871 until 1925, when the U.S. economy was expanding through industrialization, those returns were 6.6% on an annualized basis.
And then from 1926 until present day, we’ve seen stocks averaging 6.4% during a time frame where we’ve gone through a post-war expansion, the advent of the Internet and a globalization of the world economy.
And so it’s amazing to see through three very, very different time periods in our country’s history that stock performance has been remarkably consistent.
Joel: So what’s the explanation? Why has it been so consistent?
Dave: Joel, I think it points to a specific rule of investing: That stockholders are going to get paid more than bondholders. It has to do with risk. And, obviously, if you’re an owner of a company, you’re expecting to get a higher return than somebody who’s lending to the company.
That premium that you expect for taking on the additional risk of being the owner has provided that consistent return of the stock market as we’ve seen over the past 200 years.
Joel: So why is it important for investors to know about that consistency?
Dave: Joel, I think it helps us to have some confidence during times of volatility. When the markets are, in the short term, going up and down, to take a step back and to realize, “Okay. Over the last 200 years we’ve seen this consistency of return in that 6.5 to 7% range.” It gives you the ability to stay put during times like these.
Joel: Because times like these illustrate that over the long term there may be some consistency, but there are periods when stocks don’t do as well.
Dave: That’s correct.
Joel: So given that consistency, why don’t I just have stocks in my portfolio?
Dave: Well Joel, remember that consistency is based on a 200-year, long-term time frame. Okay? There’s going to be short-term volatility in the markets. So having a balanced portfolio is going to provide you with two very important things.
One is knowledge that you have your short-term cash needs taken care of – and a few years of income put aside for that.
And then, as importantly, is the fact that it’s going to give you the confidence during those short-term volatility periods to know that the stock market will return eventually, and I’m not going to make a bad decision and get out at just the wrong time.
Joel: So we like to tell people that past performance is no guarantee of future results. What if stocks lose that consistency over time?
Dave: Well Joel, you’re right. We don’t have a crystal ball and we can’t predict the future. And that’s why having a balanced portfolio is critical to your success over the long term.
But, knowing of this relationship in the market and that it occurred over very different periods of history, it does give you the confidence to know that we’ll see that type of relationship continue.
Dave Sandstrom is vice president and advisor at Landaas & Company.
Joel Dresang is vice president-communications at Landaas & Company.
(initially posted Feb. 17, 2016)
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