Friday, July 13, 2012

Are stocks really safe in the long run?

Conventional wisdom says that investing in stocks in the short run, say in a period of 5 or less years, is very risky due to volatility in the markets.  Extend the time frame to 15 or more years, the risk is minimal and they are the superior investment.  Supporting evidence for such claims often include this chart of the Dow Jones Industrial Average from 1900 to the present.

Dow Jones Industrial Average - Click to Enlarge

It is obvious that stocks performed amazingly well after the great depression into the start of the 21st century.  Unfortunately over the last 10 years things really haven't been going so well.  If we are to follow conventional wisdom then this really isn't anything to worry about since short term volatility is supposed to be part of the game.  But should we really be so secure with the idea that everything will turn out alright if we just wait long enough?

If looking at the historical performance of the Dow Jones is supporting evidence for stocks being safe in the long run, then looking at the historical performance of stocks in other developed nations seems relevant.  With this in mind, here is a chart of Japan's Nikkei 225 index from 01/4/84 to 06/01/12.

Nikkei 225 Index - Click to Enlarge

As you can see, it has been over two decades since Japan's stock bubble burst and prices are essentially where they were back in 1984.  So if back in the early 1980's you were a young Japanese business man saving for retirement investing heavily in stocks, and you continued to do so to the present day, you would have taken a big lose on your investment.

My point here is not to suggest that people avoid investing in the stock market.  I am only trying to show that there is nothing absolute about the common idea that stocks are a safe bet in the long run.  The truth of the matter is that there is a tremendous amount of uncertainty in the areas of economics and politics; much too much to naively believe in this comfy bed time story.

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