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Why Investing Is Still a Toss of the Dice

October 02, 1995|TOM PETRUNO

Investing is gambling. Don't ever let anyone try to convince you it's not so. And don't try to convince yourself.

Why dwell on this now? Not because the Dow Jones industrial average is hovering near 4,800, and is up 25% this year. Not because it's autumn, historically the diciest time of year for stocks. Not because of anything that may happen in the next three months or even three years, in fact.

Rather, it's the current raging adulation of "long-term investing" that invites a sobriety test.

Most of the advice and commentary from the financial services industry--and the financial press--today inevitably stresses the long-term payoff from stocks. Despite a constant replaying of bull and bear cycles, history demonstrates that U.S. blue-chip stocks have provided an average annual total return of 9% to 10% since the mid-1920s.

That has become a market fact that "everybody knows." And as such, it can have a powerful tranquilizing effect on investors who profess to be buying stocks to hold for the next 10, 20 or 30 years. With history so solidly in your camp, the market must be a sure thing--certainly not a gamble--for a true long-term investor, no?

No. It's absolutely still a gamble. You are betting that you will earn at least 9% to 10% a year in stocks over time. You may well earn more than that. But you also may earn much less, or you may actually lose money, even over extended periods. Wall Street and Las Vegas Boulevard have more in common than most investors are probably willing to factor into their long-term financial planning today.

Even younger investors may vaguely remember reading about the stock market's losses in the 1930s, during the Great Depression. The Dow lost nearly 90% of its value between 1929 and 1932, after a wild period of speculation in the 1920s.

Of course, the market did recover. But it wasn't until 1954--fully 25 years later--that the Dow regained its 1929 price level. In other words, 25 years just to break even.

Imagine, for a moment, that you were an investor in the 1920s. You were following a disciplined program of investing regularly in stocks for your retirement, which was then 25 years away. No doubt it would have seemed incredible to think that whatever you had in stocks in 1929 would be worth no more a quarter-century later.

Actually, that does overstate the case. You would have been earning dividends on many blue-chip stocks throughout the Great Depression. And if you had continued to invest regularly, you would have been buying stocks at dirt-cheap prices in the 1930s and 1940s.

But imagine the emotional trauma you would have endured trying to stay on an investing program after watching 90% of your assets evaporate.

You need not travel all the way back to the Depression to experience stocks' often disappointing results. In the 10 years ended in 1978, the return on the Standard & Poor's index of 500 blue-chip stocks was only slightly above 3% a year, including dividends. The retiree in 1978 who had counted heavily on earning 10% annually in stocks over the previous decade would have been terribly disillusioned, to say the least.

Even in the 1990s, the world's second-largest stock market--Japan's--provides a painful reminder of what can go wrong. The Nikkei-225 stock index has lost 53% of its value since December, 1989. For six years, Japanese investors have struggled to convince themselves that stocks will recover their losses someday. But "someday" now looks far off indeed.

There is also the matter of how stock returns are measured. We talk about indexes, such as the Nikkei or the S&P 500, because we need a benchmark, or average, of some kind. But by definition an average is a middle ground.

The majority of mutual fund investors own actively managed funds whose managers may perform better, or worse, than that middle ground over time. And that represents another challenge to the assumption that long-term investors can count on 10% annual stock returns.

Sanford C. Bernstein & Co., a New York investment firm, recently looked back at the 36 highly successful companies highlighted in the 1982 book "In Search of Excellence," by Tom Peters and Robert Waterman Jr.

The companies named in the book were said to be among the best-run businesses in America at the time. So an individual investor--or a fund manager--might logically have decided to pick stocks exclusively from that list.

Yet measured from 1980 through 1994, almost two-thirds of the 36 stocks produced returns that were below the 14.5% annualized return of the S&P 500 in that period, Bernstein found. You would have done very well in Wal-Mart, McDonald's or Walt Disney. But pity the retiree today who has been depending on IBM, oil-field services giant Schlumberger or Delta Air Lines--a few of the other "stars" of 1982--to fund a comfortable retirement.

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