When investing your money for long-term growth, it’s total return (change in market value plus reinvested dividends and interest) that counts.
Since 1926 the compound annual return on stocks has been a bit better than 11% a year.
The return on bonds has been about half as much, or 5% to 6% annually.
The compound annual return from “risk-free” investments, such as Treasury bills, has been even lower, about 3.8%. That was barely enough to keep ahead of the inflation rate, which over the last 75 years has averaged about 3.1%.
Clearly, investors need to make a substantial commitment to stocks if they seek substantial long-term growth.
For the thoughtful investor, the dramatic rise in stock prices in the late 1990s and the subsequent retreats raise number of questions:
• What portion of your nest egg should be in stocks now?
• Should you wait for a market bottom before adding to your portfolio?
• In short, when is the best time to buy stocks?
The best time to buy stocks
Many investors try to “time the market” to some degree. They sell stocks, directly or through mutual funds, when they think the market has gotten too high. They then intend to switch back into stocks after the market hits bottom.
Market timing sounds easy, but it’s not. Market bottoms are difficult to recognize except by hindsight, and hindsight doesn’t work quickly enough.
Telling statistic: According to a University of Michigan study, most of the stock market’s gains from 1963 through 1993 were recorded in just 90 trading days. Investors who were “out of stocks” for those 90 days would have missed out on 95% of the market’s gains!
If you are a long-term investor, the best time to buy stocks is whenever you have the money available.
Allocating your assets
How much to invest in stocks and how much in bonds? In part, your answer is determined by your tolerance for risk. Mainly, however, the answer depends on your time frame. Jeremy J. Siegel of the Wharton School has surveyed returns on stocks and bonds for periods going all the way back to 1802. He finds that both stocks and bonds are quite risky for investors who intend to cash in their holdings within ten years. Over longer periods, however, returns on both stocks and bonds are far less uncertain. Actually, Siegel reports, stocks have proved to be less risky than bonds for investors with holding periods of more than ten years.
“Choosing the Best Portfolio Mix” below shows the asset allocations that might be appropriate for investors at three different levels of risk.
• Minimum means that the investor chooses the least risky mix of stocks and bonds for the given period. With a ten-year holding period, for example, putting more or less than 40% into stocks would result in greater risk.
• Conservative means that the investor is cautious but willing to accept small additional risk in exchange for the prospect of extra return.
• Moderate means that the investor has average tolerance for risk.
Other authorities might recommend slightly different portfolio mixes. But most agree about the overriding significance of your investment time frame.
Because assessing your investment time frame and tolerance for risk is so vital to longterm success, you may find it helpful to ask an asset-management professional for an
Choosing the best portfolio mix
How long before you’ll want to cash in your investments? Are you willing to take a moderate amount of risk, a conservative level of risk, or no more than the minimum possible risk?
|Risk Tolerance||Portfolio Assets||
|1 Year||10 Years||30 Years|
|Source: Jeremy J. Siegel, Stocks for the Long Run (Irwin, 1994)|