The loudest refrain I’ve heard from investors and financial advisors over the past few years is the gloomy chant, “I don’t care about return on my investment, it’s return of my investment that matters most to me.” The song is a sad one, but it reflects more than a decade of woe for many investors who once loved the stock market.
Consider the numbers: the Standard and Poor’s 500 index of large U.S. stocks just recently returned to the price level it first reached in early 2000. From a low in mid-2002, it actually climbed above that level in late 2007 but then broke our hearts again by plunging to a level not seen in the 11 previous years during the worst of the financial crisis. The point is that if you ignore dividends (which, admittedly, you should not) and focus on price alone as many of us do, investing in the U.S. stock market made you nothing over the past decade or so.
Perhaps you’ve allocated some funds to emerging market equities. The ride there has been more than a little bumpy, but the MSCI Emerging Markets index of such stocks has about doubled since the beginning of 2000. Even with the added octane of less-familiar markets, however, you’re still about where you were at this time eight years ago. Many of us have concluded that it’s decidedly worse to have invested and lost than never to have invested at all.
Those results call into question the very definition of investing. To invest is to defer some gratification—spending—today with the expectation of greater gratification—the ability to buy more stuff—at some future time. Especially with results gyrating sometimes violently, which is what finance professors call “risk,” deferring gratification begins to sound like a bad idea. It sounds even worse when we consider that prices of things we want often rise even if the value of our investments don’t. While the S&P 500 made round trips back to its early 2000 level of around 1450, by 2012 you would have needed $1939.89 to buy what $1450 would have bought in 2000; owning the S&P would have left you short. After reading these numbers, you might agree with the conclusion that the experience since the beginning of the millennium will prove to have discouraged a generation of stock market investors in the way that the Great Depression did for an earlier one.
Investors are certainly voting for this conclusion with their cash. From the beginning of 2008 through August of 2012, the Investment Company Institute estimates that U.S. investors have taken $439 billion from equity mutual funds and added $982 billion to bond funds. So far they’ve done well. During that period, the Barclay’s Capital (once upon a time, Lehman Brothers) U.S. Aggregate Bond index rallied more than 30 percent as U.S. 10-year treasury interest rates fell over 200 basis points from just under 4 percent to today’s remarkable sub-1.75 percent level. So is that the solution? Stocks are too volatile, but bonds are like money under the mattress with (a little bit of) interest, so we’ve been loading up on bonds and avoiding stocks.
That conclusion reminds me of the late ‘90s when I frequently addressed investor conferences about those very bonds. My speech was always scheduled for the slot right after lunch because the organizers figured everyone would be asleep anyway. No one wanted to hear about boring old bonds when the only interesting question was which new dotcom IPO was scheduled for the next day. I argued that an allocation to high-quality bonds might cushion the blow of an inevitable stock market downturn and might prevent you from having to sell shares of good stocks at bad prices. I’m afraid that most of the audience continued to enjoy a post-prandial snooze only to wake up when the internet bubble burst, missing an opportunity to redeploy some gains from a bond investment into beaten up tech stocks in the aftermath.
My concern this time is not so much that investors will lose principal if interest rates rise sharply and bond prices fall, as they will probably at some point, but that we’re once again defeating the purpose of investing, of deferring gratification today to have more tomorrow. With 10-year U.S. treasury notes paying paltry yields and the Federal Reserve telling us that they’ll keep monetary policy extremely loose until inflation appears stable at 2 percent or maybe a bit higher, owning those 10-year notes or various other deposits or funds that pay even less means that every day you own them your purchasing power—your gratification—declines. If rising labor costs and policies designed to favor domestic demand over exports make imports from emerging economies like China more and more expensive, our problem can become even worse. Unless we can find investments (including investments in our own earning power) that can appreciate faster than the cost of the things we buy inflates, many of us may face the prospect of a declining standard of living.
There’s no investment that’s guaranteed to give us that appreciation, and hanging on to some safety to fund emergencies and unanticipated opportunities is only prudent. But while we keep singing the song of safety, we need to plan so that we can pay the band tomorrow.
Jerry Webman is the author of MoneyShift: How to Prosper from What You Can't Control and Chief Economist at OppenheimerFunds.