Stocks for the Long Run : The Definitive Guide to Financial Market Returns and Long-Term Investment Strategies

By 2060, India’s economy is projected to be larger than China’s because of its greater population growth. India is forecast to produce about one-quarter of world GDP from 2040 through the rest of this century.

There is no question that the losing IPOs far outnumber the winners. Of the 8,606 firms examined, the returns on 6,796 of these firms, or 79 percent, have subsequently underperformed the returns on a representative small stock index, and almost half the firms have underper-formed by more than 10 percent per year.

Although those who wait long enough will eventually recoup losses on a diversified portfolio of stocks, buying stocks at or below their historical valuation is the best way to guarantee superior returns.

The S&P 500 Index originally contained exactly 425 industrial, 25 rail, and 50 utility firms, but these groupings were abandoned in 1988 in order to maintain, as Standard & Poor’s claimed, an index that included “500 leading companies in leading industries of the economy.

The government can put dividends on the same tax basis as capital gains if the tax authorities allow investors to obtain a tax deferral on reinvested dividends until the stock is sold.

would the Volcker amendment, had it been law in 2007, have prevented the 2008 financial crisis? The financial crisis was caused by the overleveraging of real estate-related securities in Bear Stearns and Lehman Brothers, which were investment banks and would not have fallen under the purview of the Volcker amendment. Nor would it have applied to the insurance giant AIG, which the Fed chose to save after seeing the turmoil unleashed by the Lehman bankruptcy. Furthermore, banks that obtained loans from the Fed, specifically Citibank and Bank of America, ran into trouble because of bad real estate loans, not proprietary trading. Given this history, it is dubious that the Volcker amendment, had it been in effect in 2007, would have changed the course of the financial crisis.

At the end of 2012, the yield on nominal bonds was about 2 percent. The only way that bonds could generate a 7.8 percent real return is if the consumer price index fell by nearly 6 percent per year over the next 30 years. Yet a deflation of this magnitude has never been sustained by any country in world history.

The takeaway from these studies is simple. Broad diversification is the only guaranteed way to approximate the superior returns that stocks have historically offered investors. Putting together a narrow portfolio of stocks may be a big winner, but usually is a loser.

In the short run, however, stock returns are very volatile, driven by changes in earnings, interest rates, risk, and uncertainty, as well as psychological factors, such as optimism and pessimism as well as fear and greed.

In fact, for someone in the highest tax bracket, short-term Treasury bills have yielded a negative after-tax real return since 1871, even lower if state and local taxes are taken into account. In contrast, top-bracket taxable investors would have increased their purchasing power in stocks 288-fold over the same period.

Investors can take advantage of this mispricing by buying low-cost passively managed portfolios of value stocks or fundamentally weighted indexes that weight each stock by its share of dividends or earnings rather than by its market value.

By the end of 2012, the price of gold reached $1,675 per ounce, and $1 of gold bullion purchased in 1802 was worth $86.40 at the end of 2012, while the price level itself increased by a factor of 19.12.

Over the 210 years I have examined stock returns, the real return on a broadly diversified portfolio of stocks has averaged 6.6 percent per year.

The financial crisis of 2008 is illustrated by the following analogy. There is no doubt that the improvements in engineering have made the passenger car safer than it was 50 years ago. But that does not mean that the automobile is safe at any speed. A small bump on the road can flip the most advanced passenger car speeding 120 mph today just as surely as an older model traveling 80 mph. During the Great Moderation, risks were indeed lower, and financial firms rationally leveraged their balance sheets in response. But their leverage became too great, and all that was needed was an unexpected increase in the default rate on subprime mortgages—that “bump on the road”—to catapult the economy into a crisis.

There is a good reason why stocks are not reacting to Fed policy as they have in the past. Investors have become so geared to watching and anticipating Fed policy that the effect of its tightening and easing is already discounted in the market. If investors expect the Fed to stabilize the economy, this will be built into stock prices long before the Fed even begins to take its stabilizing actions.

As a result, proportional movements of high-priced stocks in the Dow averages have a much greater impact than movements of lower-priced stocks, regardless of the size of the company.

On September 20, 1931, the British government announced that England was going off the gold standard. It would no longer exchange gold for deposits at the Bank of England or for British currency,

A 6.5 percent annual real return, which includes reinvested dividends, will nearly double the purchasing power of your stock portfolio every decade. If inflation stays within the 2 to 3 percent range, nominal stock returns will be 9 percent per year, which doubles the money value of your stock portfolio every eight years. Despite

In 1957, IBM’s weight was two-thirds of the technology sector; in 2013, IBM was only the third largest in a sector that contains 70 firms.

The amount of $1 invested in a capitalization-weighted portfolio in 1802, with reinvested dividends, would have accumulated to almost $13.5 million by the end of 2012.

It took just over 15 years to recover the money invested at the 1929 peak, following a crash far worse than Smith had ever examined. And since World War II, the recovery period for stocks has been even better. Even including the recent financial crisis, which saw the worst bear market since the 1930s, the longest it has ever taken an investor to recover an original investment in the stock market (including reinvested dividends) was the five-year, eight-month period from August 2000 through April 2006.

in 1950 there were 14 retired persons for every 100 workers in the United States. This ratio rose to 28 retirees per 100 workers in 2013, and by 2060 it is expected to rise to 56.

I examined the buy-and-hold returns of almost 9,000 IPOs issued between 1968 and 2001. I calculated the returns based on whether investors purchased the IPOs either at the end of the first month of trading or at the IPO offer price and held these stocks until December 31, 2003.25 There is no question that the losing IPOs far outnumber the winners.

Africa remains a small part of the world economy until 2070, when it begins to expand rapidly, reaching 14 percent, the same size as the economy of China, by the end of the century.

As we explore later in this chapter, virtually no asset, except for long-term U.S. Treasury bonds, served as an effective hedge against the sudden and sharp decline in asset values that took place during the financial crisis.

The price investors paid for IBM was just too high. Even though the computer giant trumped Standard Oil on growth, Standard Oil trumped IBM on valuation, and valuation determines investor returns.

The unprecedented bull market in Treasury bonds, supported by the belief that Treasury bonds are “insurance policies” in the case of financial collapse, could end as badly as the bull market in technology stocks did at the turn of the century. When economic growth increases, Treasury bondholders will receive the double blow of rising interest rates and loss of safe-haven status. One of the prime lessons learned from long-term analysis is that no asset class can stay permanently detached from fundamentals. Stocks had their comeuppance when the technology bubble burst and the financial system crashed. It is quite likely that bondholders will suffer a similar fate as the liquidity created by the world’s central banks turns into stronger economic growth and higher inflation.

buy the Consumer Value Store chain in 1969, specializing in personal health products. The chain quickly became the most profitable division of the company, and in 1996 Melville changed its name to CVS.

the economy of China will become twice the size of the U.S. economy in 2025 if both countries’ per capita income continues to grow at recent rates.

En muchas economías, sobre todo en países menos desarrollados, la inflación está estrechamente unida a grandes déficits presupuestarios de la Administración y a un excesivo gasto público. Por