Firm Grasp of the Obvious Week at WSJ

Yesterday Wall Street Journal columnist Brett Arends reported that from 1995 you would have been better off in a money market fund than the stock market. Apparently the meaning of the Dow hitting a twelve year low took a while to sink in. Arends also tells us that “Thanks to inflation, investors have lost ground simply if they haven’t gained it.”

Today Jason Zweig picks up the theme with a column entitled “After the Crash, Stocks May Face Long Road Back; History Suggests There’s No Guarantee of Quick Rebound; Buy and Hold — for Decades?” Zweig reveals the not at all shocking truth that just because the stock market went down a lot in the last year or two that does not mean it will necessarily go back up a lot in the next year or two.

He cites a soon to be released report from a professor of finance saying that the expected time that it will take the Dow to regain its 2007 high is nine years. That is, it has an equal likelihood of getting back to its peak after 2018 as before. Zweig says that this “shocked” him. Really? In round numbers the stock market is down 50% from the peak, so getting back up requires a gain of 100%. If you are a little pessimistic and assume an 8% average return from stocks, that will take 9 years. If you think 10% sounds right, then it will take about 7 1/2 years.

There is a powerful psychology of denial that affects many people, personal finance columnists at national newspapers included. The numbers on the 401(k) statement in early 2007 just seemed so real and substantial that it is hard to acknowledge that today’s much lower numbers are just as real. People tend to expect a V pattern in stock prices, that a few really bad years are inevitably followed by a few really good years.

The stock market doesn’t work that way. It can’t. It’s like a law of nature. The market cannot let itself be so easily predicted. Knowing what happened one year tells you (almost) nothing about what will happen the next. Since 1871 the stock market (as measured by the S&P 500) has had 38 down years. Excluding this year, the average return the year after losing money is +11.63%. The S&P has also gained more than 20% in a year 38 times. The average return in years following big gains is +12.27%.

There is obvious incredulity in the question “buy and hold — for decades?” But the straightforward answer is “Yes, of course.” Did you think that you could guarantee fat stock market returns if you were willing to stick it out for five or ten years? You can’t, and that’s something that all stock market investors, and all Wall Street Journal columnists, need to know.

Investing | Frank Curmudgeon | February 26, 2009 9:53 am

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