Thursday, September 25, 2008

Value Investing Today: Chp 12: Are Stocks an Intelligent Investment?

Brandes explores the idea of whether stocks have historically been a good asset class to invest in. He references a report by Ibottson that shows 75 years of return performance for the S&P 500 stocks, U.S. government bonds and U.S. government treasuries. The compounded rates of return over that time frame are 10.2%, 5.5% and 3.8% for the stocks, bonds and cash asset classes respectively. He concludes, that at least historically, it was prudent to have money invested in stocks over that time horizon.

Brandes takes a closer look at gold and real estate as alternative investments to stocks. First, with gold, he states that although it has a reputation as being an inflation hedge, the metal has only returned 2.6% compounded annually between 1900 and 2000. With inflation averaging 3.2% over the same period, he concludes that gold has not historically been a good hedge against inflation. In addition, even if you looked at the "golden" age of gold, between 1926 and 1981, the price of the commodity only rose 5.8% per year, which is just a little over half the return of the S&P 500 over the same time period.

Brandes comments that real estate without the effects of leverage has not been a great investment over time compared to stocks. One report by Ibbotson shows a 7.6% average yearly return for real estate versus 12.7% return for U.S. stocks between 1982 and 2002. He also makes the argument that people need businesses to generate the income to pay for their homes. His opinion is businesses have to do well in order for real estate to do well and that businesses need to be more profitable than real estate (as investments), otherwise, real estate would be largely unaffordable.

Since investing in stocks appears to be the prudent choice, Brandes takes a look at investing during adverse conditions, namely, during market declines. He notes that there have been 12 major market declines of 15% or more in the S&P 500 since World War II. The average duration of these market declines was 12.5 months. However, the average market rise in the first year following each of these 12 periods has been 31%! This demonstrates the resilient ability of the market to recover from adverse price conditions.

Brandes is not a proponent of market timing because of the impossibility of accurately predicting each market bottom and also the potential for losing out on stock appreciation by not being invested in the market. He references research that demonstrates $100,000 invested in the S&P 500 between 1983 and 2002 would have appreciated to $625,583. The amazing fact, is if investors missed just 10 of the biggest market gain days in that time period, the $100,000 would have grown to only $365,750, or 41.5% less than if investors had remained in invested continuously.

Brandes concludes that time is the most precious commodity to investors, and that time in the market will be an advantage to those seeking long-term appreciation of wealth.

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