If you ask any financial advisor, investment firm, or just consult conventional wisdom on where to invest any extra money you might have for a medium to long period of time, the advice will be to invest in the stock market since it provides the highest annual returns over the long term. That return, you will be told is about 10%. But that number has significant problems.
First, it is not adjusted for inflation. Over the last 20 years (2000-2020), inflation has averaged 2.1% so the 10% return rate is more correctly 7.9%. But the last 20 years were unusual mostly for the artificially low rates of money that the Federal Reserve used to keep the cost of credit low. Other periods of history had much higher rates of annual inflation such as the 1968-1991 period (24 years) where inflation averaged 6.1% bringing that annual stock investment return down to 3.9%. That doesn’t include shorter periods like the three-year period of 1979-1981 where inflation averaged 11.7%, thereby exceeding the average historical stock return.
We have enjoyed the benefits of low interest rates from Federal Reserve action, but with inflation now at 8.6% with even the President predicting that inflation will be a “haul” and “take some time,” the party is over. After years of keeping interest rates artificially low followed by over $5 trillion in federal Covid relief along with another $4 trillion from the Federal Reserve, all of which was printed or borrowed, the chickens have come home to roost. Compare that to the pre-pandemic federal budget of $4.5 trillion which had only enough revenue to cover 80% of it. A balanced budget has only been produced four times since 1968 so altogether our national debt is now at $30.4 trillion, a 31% increase over 30 months. Where inflation will go and how it will fully affect the economy no one knows, but it is apparent that Wall Street is pessimistic and stock values have fallen into a bear market.
Since a bear market is generally defined as a decline of 20% in stock values, if you had $100,000 in investments in January of this year, its value is now $80,000. But this is also misleading. The decline in stock value is calculated by a major stock index such as the Dow Jones Industrial Average which only contains 30 of the highest value “blue chip” stocks like Apple and Amazon or the S&P 500 index which contains 500 of the largest company stocks. Yet there are more than 2,500 companies trading on the New York Stock Exchange (NYSE). How have the stocks of the rest of the non-index companies fared recently – or over the history of the stock exchange?
Investment professionals don’t want you to know because they want you to invest in mutual funds or pick stocks for you and charge fees to “manage” their recommended consistent steady investment inflows by you. These highly sophisticated and knowledgeable managers of mutual funds peel “management” fees of 0.5%-1.5% off of your annual mutual fund returns (even negative ones). These fees are charged despite 80% of managed funds not being able to beat the performance of an index fund (which are also charged fees but at a lower rate). An index fund is just a simple proportional sampling of stocks in the Dow or another index. I don’t have a citation but I recall reading on several occasions 15-20 years ago that almost no managed mutual funds had beaten a major index fund’s performance.
At that time, for those employees who had access to deferred compensation plans or 401Ks, index funds were not even offered as a choice and the selection of funds were limited. Now, in almost every case, employers do offer index funds and a wider selection of mutual funds but not access to individual stocks – which is probably a good thing. In the case of defined benefit pensions, the future pensioner has no say in how the pension funds are invested or how much fees may be incurred or pension managers wined and dined.
But perhaps, the biggest myth about the historical rate of return of stocks is the implication that history contains an apples to apples comparison over time when that could not be farther from the truth. The NYSE was officially started in 1792 by 24 stockbrokers under a buttonwood tree on what is now Wall Street. But the time frame for which the 10% annual return is calculated is much shorter dating from 1926.
Think about the vast amount of change that occurred in U.S. history with industrialization and the economy in this relatively short timeframe of 106 years: the spread of electric lighting, the rise of the automobile, jet plane travel, World and other wars, computers, the internet, etc. Just astounding changes. Comparing the 1930s to the 1950s or the 1990s or any decade against another is more like comparing apples to fig newtons. There has been too much going on in a short period of time to develop a reliable pattern.
You can see that there are significant periods of decline despite the overall upward trend. For example, for 17 years from 1966 to 1982, the market declined (and that does not include inflation or fees). If you were a person old enough (40 – 50 years old?) to have saved enough money to invest in 1966, it would take not only the 17 years of decline in your investment to pass but another 13 years until your stock value returned to its 1966 level in 1995. That would put you at 70 – 80 years old not even accounting for inflation and fees. So, there would be a good chance of dying before you saw any gains from your investments. Not a very enticing scenario. You can see similar shorter but still lengthy periods of stagnation besides the one described.
Lastly, Wall Street, has been provably and excessively corrupt time and time again, from the early Wall Street banking titans like J.P. Morgan to the recent. GameStop/Robinhood collusion with Citadel Securities – too many episodes of exploitation and outright law-breaking to recount. It is the nature of the system on Wall Street to exploit the piles of money at their disposal and break the rules. If they get caught, the penalties are almost always a relatively minor fine. If a scheme goes bad, they will get bailed out because of the domino effect with the vast amounts of money at stake that could destroy the economy. How does one factor in the cost of massive bailouts and corruption into the 10% annual return rate?
The traders make a fortune while the average investor struggles with the hard reality of reliably making money in the stock market. It’s not to say that it can’t be done, or that I can offer a pile of better alternatives, but if and how it happens is unfortunately beyond your control.