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That is sage advice from the early twentieth century cowboy, social commentator, and one-time presidential candidate, whose aphorisms resonated with the average American. Buying good stocks historically has been a prudent recipe for building wealth. Naturally, one can’t know with certainty what a stock will do before it is even purchased, but there are ways to make educated assumptions about the anticipated performance of an equity investment. Professional investors do it every day.
At the heart of Rogers’s advice is that you have to make an investment—you have to take on some risk—before you can reap any rewards. Equities historically have been a critical component in the long-term success of investors. Over the long run, stocks have demonstrated the ability to create wealth that may provide investors and their families some financial security.
It’s true that stocks may experience periods of volatility. They may even decline significantly in response to adverse events in the corporate, regulatory, economic, market, or political arenas. Still, avoiding exposure to equities carries its own set of risks. Equities offer the potential to grow assets and outpace inflation, which can erode purchasing power. In the prevailing environment of historically low interest rates and slender yields on traditionally lower-risk, fixed-income investments, equities offer an investment alternative with the potential for greater returns in exchange for assuming marginally greater risk over the long term.
While we think there are solid reasons for investors to consider increasing equities holdings now, there are compelling arguments to be made in favor of equity investments in any diversified portfolio at any time. Among them are:
1) History has favored a return to the mean. And history has favored long-term investors. It’s true that the financial crisis of 2008–09 was painful for most investors, but volatility and occasional severe corrections are some of the risks of investing. The long-term history of the stock market, though, demonstrates a continual upward trend: Since 1929, there have been 60 years of positive returns and 24 of negative returns.2 In other words, returns were positive approximately 70% of the time on a yearly basis.
More telling, however, is the longer-term picture. When returns are measured over rolling 10-year periods, they were positive 95% of the time, starting with the 10-year period ended in 1935.3 Of course, the last five years have seen two negative 10-year periods—ended in 2008 and 2009—which are still fresh in people’s memories. But if history is an indicator—and there is no guarantee that it is—investors may be expected to experience a period of more normalized returns going forward. Once again, using history as a reference, since 1926, the worst 10-year periods of returns have been succeeded by decades that rewarded stock investors for their patience. It remains to be seen, however, whether the 10-year periods following the decades ended 2008 and 2009 (when the S&P 500® Index returned -1.38% and -0.92%, respectively4) will repeat the pattern, but the years since 2009 have been beneficial to equity investors overall.
2) Equities may help protect purchasing power. Whether inflation comes roaring back or creeps in on little cat feet over time, it is not likely to remain at its current historically low levels. Although inflation has not been a buzzword since the 1980s, the Federal Reserve’s unprecedented stimulus program of quantitative easing over the past five years has created uncertainty with regard to the future of prices. Investing in assets that have the potential to outpace inflation could protect your portfolio against the inevitable reality of rising prices and eroding purchasing power. History demonstrates that equities have surpassed inflation—and other assets—by a significant margin over the long term (see chart). Admittedly, there is no guarantee that the pattern will continue—but the potential exists.
Returns for $1 invested on December 31, 1978, through December 31, 2012, after the rate of inflation has been removed†
Source: Lord Abbett.
Stocks are represented by the S&P 500 Index. Bonds are represented by the Ibbotson Associates SBBI Long Term Corporate Index. Cash equivalents are represented by the P&R 90-Day U.S. Treasury Index. Gold is represented by the S&P GSCI Gold Spot Index. The U.S. dollar is represented by the growth of the nominal dollar, with the rate of inflation subtracted. †Inflation is determined by the Consumer Price Index.
Performance data quoted above are historical. Past performance is no guarantee of future results. Current performance may be higher or lower than the performance data quoted. This chart is for illustrative purposes only and does not represent any Lord Abbett mutual fund or any particular investment. The hypothetical investment values reflected do not reflect the fees and charges associated with specific investment products nor do they account for taxes. If included, the results depicted would have been significantly lower. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.
3) Owning quality companies can be a hedge against the short-term vicissitudes of the market. Economic and geopolitical upheaval can wreak turmoil in markets and, in the short term at least, sweep market participants along with it. But over the long term, well-managed, quality companies tend to endure and often are best positioned to thrive in a recovery.
Renowned investor Peter Lynch summed it up in his book, Beating the Street: “Often there is no correlation between the success of a company’s operations and the success of its stock over a few months or even a few years. In the long term, however, there is a 100% correlation between the success of the company and the success of its stock. This disparity is the key to making money; it pays to be patient and to own successful companies.”
In addition, quality companies with strong balance sheets and consistent cash flows may offer investors another opportunity for returns in the form of dividend payouts. For more than a century, reinvested dividends have accounted for 40–60% of equity returns.5 Historically, companies that have initiated or grown dividends have outperformed companies that have cut dividends. Consistent dividend payers historically have produced better overall results.
4) In an increasingly globalized economy, equities potentially provide a way to participate in the wealth generation of companies beyond the U.S. borders. Globalization has blurred the lines between investing in the United States and investing overseas, making it easier than ever to do either or both. Indeed, with consumer demand growing exponentially in countries outside the United States, the opportunities for investment abound.
Further, the opportunity for dividend income is even greater beyond the U.S. borders. There are 747 companies in the world with a market capitalization greater than $1.5 billion that pay out dividends of 4% or greater. Of these companies, 77% are overseas and 27% are in emerging markets. Of the 747 companies, 49 have dividend yields greater than their price-to-earnings (P/E), and just 14 of those companies are located in the United States.6
Of course, global investing requires rigorous due diligence, and investors are wise to seek professional guidance.
5) The chance to own a piece of the next big thing. Ten years ago, no one had heard of the social networking service Facebook; it didn’t exist until 2004. Portable tablets were in their infancy, and no one was tweeting. Apple was reinventing itself, as it has done multiple times since 1976, when it introduced the Apple 1 computer kit.
Investing in the stock of innovative, smart, visionary companies potentially gives you the inside track on capitalizing on the next big idea. Shareholders who take the calculated risk of investing in a company are, consequently, the ones who reap the rewards for that risk. Whether it is nanotechnology, green energy, or biomedicine, innovation has always been the engine of the capital markets.
But before you inadvertently funnel your hard-earned money into the twenty-first century equivalent of the Chia Pet or mood ring, do your homework. Better yet, let the experts do it for you. Experienced investment professionals, backed by thorough fundamental and quantitative research, are trained to distinguish the potential opportunities from the probable pitfalls.
In It for the Long Term
There will, of course, likely still be bull and bear markets, recessions and expansions. However, investors are right to reconsider the reason they owned equities in the first place: the prospect for long-term growth. Equity, after all, represents ownership in a growth proposition—a share of a company that seeks to grow profits through innovation, execution, and prudent financial management, with some volatility along the way.
The Fed and the U.S. government are expected to continue to act and react to economic data with countercyclical measures aimed at moderating the business cycle. Interest rates are expected to remain low for the foreseeable future, which in turn will continue to fuel the search for yield. Equities represent a potential opportunity for greater returns in exchange for a lesser degree of certainty. Within the realm of equity investing, there are myriad asset classes and strategies designed to meet the particular goals of individual investors. Investors willing to take on a little more risk might do well to explore these opportunities.
Some Risks to Consider: The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. Investments in small and mid-sized companies involve greater risks not associated with investing in more established companies, such as business risk, significant stock price fluctuations and illiquidity. Investing in international securities generally poses greater risk than investing in domestic securities, including greater price fluctuations and higher transaction costs. Special risks are inherent to international investing, including those related to currency fluctuations and foreign, political, and economic events. These risks can be greater in the case of emerging country securities. The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall. No investing strategy can overcome all market volatility or guarantee future results.
Dividends are not guaranteed and may be increased, decreased, or suspended altogether at the discretion of the issuing company. Diversification does not protect an investor from market risk and does not ensure a profit.
Glossary of Terms:
The S&P 500® Index: Is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries.
P/E ratio: Price-to-earnings ratio is a valuation ratio that compares a company's current share price with its per share earnings.
S&P GSCI Gold Spot Index: Serves as benchmark for investment and as a measure of commodity performance over time.
The Consumer Price Indexes (CPI) program produces monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services.
Earnings per share (EPS) is the company's net income divided by the number of outstanding shares of common stock. EPS is often calculated using the average number of shares outstanding during a period, such as a quarter. This is considered more accurate than the number of shares outstanding on a particular day. EPS can be calculated using earnings over the past year or using estimates of earnings for the coming year.Ibbotson Associates SBBI Long Term Corporate Index: A market value-weighted index that measures the performance of long-term U.S. corporate bonds. The index includes nearly all Aaa- and Aa rated bonds with at least 10 years to maturity. The Ibbotson U.S. Long-Term Corporate Bond Index includes reinvestment of income.
P&R 90-Day U.S. Treasury Index: An index based on the auctions of U.S. Treasury bills, or the U.S. Treasury's daily yield curve. Represents a minimal rate of return investors could expect from almost any bank.
Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.