Why Stocks Are A Bargain (According to Kiplinger’s)?
Posted by Frugal on April 2nd, 2007
In the April’s issue, Kiplinger’s personal finance brought out the author James K. Glassman who wrote the book “Dow 36000″ in 1999 to talk about the “risk anomaly” between the long term performance of stocks and bonds. I fully agree with him that LONG TERM stocks are a much better choice than bonds. But the unforunate news is that long term can sometimes mean 20 years. (for example, from 1929 to 1949, the annualized inflation-adjusted return was 1.2%, and from 1966 to 1982, the annualized inflation-adjusted return was -1.5%).
How many 20 years can you afford to wait? At most two. 20 to 40, and 40 to 60. Actually unless you have planned and saved diligently from 20 to 30, your salary usually is not at its peak earning power for majority of the career choices. If you count from 30 to 50, you probably have only 1 twenty years period available for you to save & invest, assuming that from 50 and beyond, you will shift your portfolio to a more conservative allocation.
Despite the recent stock market fall, everywhere I looked, I see very few signs of panics and bearish sentiments in the general investing public, including this article from Kiplinger’s. This is probably not a good sign, although not a strong predictor for future stock market performance either.
Coming back to Glassman’s point that the long term excellent performance of stocks versus bonds means that stocks should not be “riskier” than bonds, I must argue that there are really two dimensions to the word RISK. Usually the simplest terms from probability theory, besides mean (or so-called average), the second order term is standard deviation. You must consider both. Even though the average return is better, the standard deviation of the return is much bigger in bonds than in stocks in stocks than in bonds (must be sleeping when I typed that). That’s what I call RISK, a bigger standard deviation in the return (in the short term).
I have serious doubts about the recent double bottom in the stock indexes. I still believe that there will probably be a lower low ahead of us this year. Although the technical charts of the stock indexes look good, fundamentally speaking the stock markets are facing one of the most serious situation: inflation that is simply not going away plus a slowly deteriorating housing market plus an unstable mid-east conflicts. I simply cannot concur “why stocks are a bargain”.
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April 2nd, 2007 at 8:11 am
Glassman has been a columnist for Kiplingers for over a year now. I almost cancelled my subscription when I first saw that. He skirts around the things that he wrote in “Dow 36,000″ but he clearly says in October 1999, that the Dow will get there sooner than later. I didn’t cancel for two reasons. 1) they have other good articles and writers. 2) I don’t want to stop listening to opposing opinions.
April 3rd, 2007 at 12:02 am
I am guessing you meant to say that stocks have a larger standard deviation than bonds when it comes to returns (and not the other way around).
With respect to the time you can afford to wait for stock market returns to pick up: (i) you make some good points; (ii) even when you are in retirement you should keep a considerable part of your portfolio in stocks, so in reality you will likely experience about 3 20 year periods over your investing life.
Also, everyone acknowledges that stocks are indeed a long term investment. That is one of many reasons I consider stock picking to be an unwise thing to do.
April 3rd, 2007 at 1:22 am
LAMoneyGuy,
Listening to opposing view is very important, even from a crazy person. Sometimes, they may just be right. Kiplingers overall is pretty good.
April 3rd, 2007 at 1:29 am
Shadox,
Thanks for your correction. I was probably sleeping when I typed that.
Yes, there may be 3 periods of 20 years, if you add 60 to 80. But due to the standard deviation in stocks, I think it’s probably a safer practice to keep more bonds, especially you will be withdrawing from your investment. That factor can wreck your entire portfolio when you need to keep your money in the market most.
The best years are probably just 20 years within 20 to 60 years old timeframe, because there probably will be some 20 years during which you can’t save much due to a young age yourself or kids growing up.