It's common to hear in conversation from Wall Street to Main Street that stocks are the best place to park your money for the long term. But are they really? With commodities like oil and corn getting a lot of attention from institutional traders, it's a lot less clear what the best earners are any more. Let's take a look.
Why People Think Stocks Are No.1
It's clear why stocks take the spotlight of the investment world; they're accessible! According to a 2005 survey by the Investment Company Institute and Securities Industry Association, more than half of American households own stocks.
The fact that so many of us have stocks on the brain has brought many to question whether stocks are the place to be, especially when the market's down. The pros say that when you hold stocks for the long term, you can expect returns of around 10% annually. Is that true?
There's no question that over very long investment horizons, stocks have historically shown impressive returns. One of the best gauges for the state of the stock market is the S&P 500 Index. From May 1970 to May 2008, the index, which is composed of the biggest 500 stocks, has returned roughly a solid 1400%. Another behemoth benchmark is the Dow Jones Industrial Average - it has returned close to 1450% over the same period.
That certainly sounds like a great return, but let's go ahead and do the math. When you take out inflation, which is roughly a cumulative 460%, you're left with an average of almost 25% annualized returns. That seems like a pretty huge number - much more than the standard 10% - but don't expect to see that in your portfolio every year. (For more insight, read All Returns Not Created Equal.)
Less Time = Less Money
Why are we seeing 25% returns when we crunch the numbers? Well, a big part of it is the time period we're looking at - granted, while it's almost 40 years, we're looking at one of the most profitable periods the stock market has ever seen. When you take a look at smaller periods of time, things break down a bit.
For the 12 months ending in June 2008, the S&P and the Dow each shed close to 8%. If you're wondering how these monster-sized indexes can throw gains at investors one year and take them back the next, it's important to think of these numbers in context. "Long term" for stocks can be 10 or 20 years down the road - 12 months doesn't cut it.
In other words, stocks are very volatile investments in the short term. The idea behind buy-and-hold investing is to average out the peaks and valleys on a stock's chart, and focus on the long-term trend. That's why your time horizon matters.
Stocks 1, Bonds 0
Another reason that stocks are generally seen to come out on top is that over time, bond returns don't measure up to stocks. Between 2002 and 2007, the average high-yield bond fund brought in 7% versus the S&P's almost 45% (in all fairness, the average large-cap stock fund only earned 9% according to Morningstar). The same is true of money markets and certificates of deposit (CDs). In his book, "Stocks for the Long Run" (1994), Jeremy Siegel shows that, in blocks of 20 years, stocks outperform bonds 90% of the time.
But bonds, money markets and CDs do have their uses; in addition to being very low risk places to stash your cash, these vehicles are also great places to put money for the short term with almost no risk. In fact, most stock mutual funds sweep unused cash into money markets overnight to lock in some small gains. (To learn more about mutual funds, see: Special Feature: Mutual Funds.)
If you owned a CD paying out 3% in 2008, your CD beat the S&P in the first half of that year. Same deal if you were in a bond fund, like T. Rowe Price's Inflation-Protected Bond Fund, which made more than 3% over that time.
However, despite the value of these lower risk types of investments, stocks win this one if you consider the long-term returns.
Those Crazy Commodities
Another area worth looking at is commodities. Agricultural goods like corn and rice first reached their all-time highs in 2008, and we all know that oil has been no slouch either. (For related reading, see Commodities:The Portfolio Hedge.)
But believe it or not, even oil can't measure up to the S&P over the years. Since 1970, this "black gold" has only brought in an annualized return of 15%. While commodities tend to see wild short-term movement that traders use to bring in massive returns, in the long-term, they don't hold a candle to returns generated by stocks. That's no surprise according to a 2008 paper by Wachovia's Economics Group entitled "Commodity Prices in Historical Perspective", which states that "nominal commodity prices have risen less than the prices of most other goods and services over the past three decades."
Stick With Stocks
So, does this mean that stocks really are the best place to put your money for the long term? The short answer is yes.
Stocks have proved to be the place to put your money if you're willing to hang on over a period of years. So how can you use this little gem of knowledge to your advantage?
For starters, if you're a more self-directed kind of investor, you should keep in mind that stirring the pot too much can take away from the historical advantage stocks have shown us; with added transaction fees and short-term volatility, portfolio churn can be a bad move if you're hoping for some of those laissez-faire gains. (For more information, read Market Timing Fails As A Money Maker.)
One way to see good returns without all the legwork is to identify funds that can stick with you for a while. Index funds and ETFs are a good choice - they feature low fees and high diversification, and ubiquitous indexes like the Dow and S&P have consistently performed well over time. While no investment is guaranteed, as you can see stocks have shown themselves to be the top performer for investors.