The Future of the Stock Market

The following is reprinted with permission from Generation Earn: The Young Professional's Guide to Spending, Investing, and Giving Back. Copyright © 2010 by Kimberly Palmer, Ten Speed Press, an imprint of the Crown Publishing Group, Berkeley, CA. You can find out more about Kimberly at the Alpha Consumer blog.

The 1990s are over. And they’re not coming back.

That’s good news for those of us who were never fans of the grunge look, but bad news for anyone hoping to earn 10 percent returns every year. Books, magazines, and other sources of personal finance expertise continue to push the notion that we shouldn’t worry about the fact that, after we factor in the recent down market, the stock market has returned next to nothing over the past ten years.

On average, these stock market cheerleaders say, returns have always historically returned to around 10 percent a year. But it’s very possible—probable, some might say—that they are wrong, and that 10 percent average returns were an anomaly unique to the twentieth century.

Since 2000, returns have been significantly lower. Some prominent sources, including the Economist and Wall Street Journal, have even referred to the 2000s as a “lost decade” for investors. Anyone trying to estimate their returns for the next few decades might want to consider using a more conservative estimate of 6 or 8 percent returns, and even that feels a bit optimistic. After all, Japan’s stock market is still struggling to return to levels it experienced two decades ago.

But rather than wallowing in potential doomsday scenarios or lamenting how unlucky our generation is that the stock market started sinking as soon as we began investing in it, we can consider ourselves fortunate that the crash of 2008 didn’t come later, when we were closer to retirement.

Or we can simply be grateful that it happened. As Suze Orman has pointed out, if the economy had kept on going the way it did in the 1990s, we would still be buying expensive stocks and overinflated real estate. The financial crisis, she says, is the greatest thing that has ever happened to our generation. (Suze, of course, says this with the knowledge that most of her money is safely ensconced in bond funds.)

People who are just starting to invest have had a unique opportunity to buy into the stock market at the lowest prices in years. And plenty of experts are quick to point to the data on historical returns, which suggest that there’s no way we could possibly have two “lost decades” in a row, and market returns will surely rebound back to twentieth-century levels before too long. Meanwhile, we can take steps to make the most of the post-credit crunch markets, starting with these pieces of advice:

• Accept reality. The heyday of easy returns and overnight millionaires is probably over, at least for now. We can’t count on the stock market returning to 10 percent returns anytime soon. That means you’ll need to save more to achieve the same long-term wealth goals.
• But don’t give up on the market. It still offers the potential of steep rewards. Selling stocks after the market has plunged only guarantees you one thing: losses. As long as your investments are well diversified (index funds and mutual funds that are exposed to a broad range of sectors) and age appropriate (more aggressive when younger, more conservative when older), then you should just sit back, relax, and try to think about something other than the stock market.
• When the market drops, rebalance your accounts. Dramatic losses often mean you have a greater percentage of your money in safer investments, such as bonds, and a smaller percentage in more aggressive, longer term stocks, since your stocks have lost so much value. For example, if you had half of your savings in stocks and half in bonds, after the market plummeted you would suddenly have most of your money in bonds.

Rebalancing can mean buying into a weak stock market, which goes against instinct, but it’s often a winning strategy. Research suggests that investors often fail to make these adjustments, which costs them in the long run. One ING DIRECT study found that two in three Americans made no adjustments to their investments in the wake of the most recent recession.

• Learn from your mistakes. Even professional investors make mistakes, especially at first. J.D. Roth of Get Rich Slowly lost money investing in Sharper Image before deciding to stick with index funds. Even after studying the basics of investing, most of us are pretty much destined to make mistakes, especially at first. That’s another reason to start investing as soon as possible.

Comments

[jason]

"One ING DIRECT study found that two in three Americans made no adjustments to their investments in the wake of the most recent recession."

I have been told by several people who lost big during this time that they were strongly encouraged to "stick it out" by their investment company.

Whats funny to me is the article explains to accept reality, yet dont give up. Also at the very end it says learn from your mistakes. I'm not sure that you can call what happened before/during the recession a mistake because people were invested many years before this happened and lets face it, those individuals had no control of the stock market and what it was about to do. Even if it was a mistake on their part, I wouldnt blame them for being a little gunshy now. This advice may work well for younger folk, but as a younger person myself, I have no trust, faith or reason to believe the stock market will ever make me any money.

[MonkeyMonk]

Or you could practice a little simple market timing. It didn't take a genius to figure out that the markets were going to tank two years ago and I (like others) shifted a good portion, but not all, of my investments into a safer investment vehicle. Maybe I was just lucky but it didn't feel lucky at the time. I'm back to close to my original levels in equities but starting to mull the possibility of doing a similar move.

Yes, I missed the top and bottom of the markets by quite a bit but it still reduced my losses to about two-thirds compared to what they would have been in I had left my money sitting in the same funds.

Yes, I missed some of the best trading days of the recovery. But I also missed a bunch of the really crappy days of the decline. In my case I happened to miss a lot more bad days than good days.

All that money that people lost in the stock market crash didn't just go *poof* and disappear. For every dollar that was lost somebody else made that dollar.

[Tyler]

"People who are just starting to invest have had a unique opportunity to buy into the stock market at the lowest prices in years"

This logic is just wrong. 1 define cheaper/lowest price. 2. define fair value. 3. define risks.

Save more to make up for lower returns- spot on.

"Selling stocks after the market has plunged only guarantees you one thing: losses." These comments are unintelligent at best. It shows an inflexibility of thought and boxes one into a fixed response to variable information. Selling losing positions also guarantees you cash. Guarantees you survive. Define a plunge for us. Stay flexible to change.

There are some solid yet basic thoughts, but the 'rookie' comments overshadow any value.

[Old Limey]

The stockmarket is a roller coaster marked by long periods where the net return is very low, short periods where the net return is very high, and short periods where the net return is very negative.

1970 - Mid 1982 ------- Flat.
Mid 1982 - Oct 1987 - Up big time.
Oct 1987 ----------------- Huge crash.
1988 - Mar 2000 ------- Up big time.
Mar 2000 - Mar 2003 - Down.
Mar 2003 - Oct 2007 - Up.
Oct 2007 - Mar 2009 - Down.
Mar 2009 - Today ----- Up.

9/1/88 - Today (22 years) - Dow Industrials annual rate of return=8%.
1970 - Today (40 years) --- Dow Industrials annual rate of return=7%.

Considering that today's unemployment rate is abnormally high and that budget deficits and the national debt have soared and that current economic measures being taken are lowering the value of the dollar and increasing the price of commodities with no sign of returning to normalcy I agree that 6%-8% returns are more likely in the future for long term buy & hold investors of stockmarket index funds. Some indexes are a lot hotter than others and many traders do very well trading in and out of the hot indexes but that isn't something that is easily done if you are very busy working during the day and don't possess the tools and expertise to do your own technical analysis.

In my own case, as a retired 76 year old, since Oct/2007 I have been 100% in fixed income investments and my current rate of return at this time is 4.87% (tax exempt and tax deferred) with almost no volatility. The only trading I do is when one of my investments matures or is redeemed and I need to replace it.

[Lurker Carl]

A fluff piece touting worthless advice.

[Old Limey]

Monkeymonk:

If I or anyone else bought a share of stock at 50, it then went to 100, and then went back to 50, hasn't my one time unrealized $50 profit gone *Poof*?

What's the difference between this and the housing market?

Add up the value of all the homes in the USA at the height of the real estate bubble and then compare it with the value of all of those homes today - you end up with a very large negative number.
Bottom line - those huge unrealized gains at the height of the market have gone *Poof* because the vast majority of homes haven't changed hands.

[Anonymous]

I rebalanced but did not pull any money out in Jan 2009 when my portfolio was down about 39% from its previous high value. Since the rebalance, I have matched the performance of the NASDAQ and exceeded the other indices (DJIA, S&P, Russell 2k).

I am up about 19% this year.

[Tyler]

Monkeymonk- the stock market is not a zero sum game. Thus money can go 'poof'. When a stock goes from 50 to 100, you are valuing your position by the last trade not what someone is willing to pay for your actual position. Your position is only worth 100 when you sell it for 100. Thus it can go poof. Until you sell, its simply an accounting transaction (not a zero sum as you presume). Old Limey has said roughly the same thing already.

[jim]

"The financial crisis, she [Suze Orman] says, is the greatest thing that has ever happened to our generation."

What comment from Suze Orman is this based on?? That really does NOT sound like something Suze would say. It isn't a direct quote. This looks like something taken out of context and misconstrued.

"Even professional investors make mistakes, especially at first. J.D. Roth of Get Rich Slowly lost money investing in Sharper Image..."

From GetRichslowly, JD says: "Please note that I am not a financial professional." I don't know why she would think JD is a "professional investor". He writes a blog on personal finance, that does not make him a professional investor.

[jason]

Wow, I think its safe to say this article is not contributing positively for FMF.

[Old Limey]

As much as I think Suze Orman makes a lot of sense almost all of the time, the greatest thing that has happened to this generation is undisputedly the introduction of "THE INTERNET".
Just imagine how different your life would be without it, especially those of you that have iPhones or the like.

[jim]

Ok, I guess Suze Orman did say that. I did a little searching...

http://money.usnews.com/money/personal-finance/articles/2009/06/23/suze-orman-why-the-recession-is-a-good-thing.html?PageNr=2

Orman: "This is the greatest thing that has ever happened to youth. It gave you a wake-up call that your parents were living infinancial la-la land. They were just trying to impress everybody with money they didn't have. Your parents and grandparents were trying to keep up with the Joneses without having a clue that the Joneses had $50,000 in credit card debt, and that's why they could afford a third home."

[frodo]

Agreed to expect only 6-7% average returns, but I'd expect 10-15% for the next few years since the markets are still undervalued. We had 27% in 2009 and are on pace for around 12% in 2010. Once the S&P 500 hits around 2,000 or so, I'd expect things to slow down.

[Mark]

The difference between the stock market and the housing market is that the housing market is practically a zero-risk investment. Even when grossly overpriced (I sold my California house in November, 2005, after it had tripled in value in three years), many people went on a buying spree--lured by greed and Realtors telling them real estate only goes up. Well, many of those people put no skin in the game, defaulted, and got to live in the house for several years without making payments. And in non-recourse states like California, you can default on a first mortgage and owe nothing more, even though you may have just cost the bank (taxpayers) hundreds of thousands of dollars. Then these deadbeats will come back in a few years and buy another house, all without paying the former bill due to their poor investment. Such is not the case with stocks or stocks bought on margin.

[Revi Samson]

"We can’t count on the stock market returning to 10 percent returns anytime soon."

Since Jan 1st, 2009 the S&P 500 is up almost 40% in a roughly two year time frame. Hopefully the author is right and we won't be returning to 10 percent returns anytime soon...

[Sunil from The Extra Money Blog]

market timing and picking stocks is simple foolish. sure some have made money doing so, but at the expense of 80% of the other investors who end up losing as a net result.

i stick to value index funds much like FMF does. i invest regularly and consistently (dollar cost), and have done relatively well.

while i agree with the historical v present analysis, i also agree that one shouldn't give up on the market. the 90s may not come back, but does it really have to? sound, value investing over the long haul is key, in good times or bad. trust the money manager of the mutual fund who has a ton more experience that likely you do, and keep your role to a high level oversight and decision making

[janetj]

The same author will probably write another article in a few years about how you should have stuck it out in the market during these lean years, and nobody will call him on it.

Rule of janetj: Buy during bad times. Sell some during good times.

[Tyler]

So janetj, based on your 'rule' you are a market timer. I wanted to make sure you realize that you're statements contradict each other.

[Felix Guzman]

SELL EVERYTHING YOU HAVE IN THE STOCK MARKET, NOW!!!

[jim]

"market timing and picking stocks is simple foolish. sure some have made money doing so, but at the expense of 80% of the other investors who end up losing as a net result."

One person doing well at picking stocks does not come at the expense of other investors. If I bought Apple in 2008 to see it then triple, how does that come at the expense of anyone else??

[janetj]

Tyler,

Nope - Market timing involves guessing. Buying during down markets and selling when markets are overpriced is simple common sense.

[jim]

Janetj, you're still timing it to determine exactly when the market is down or up.

[Tyler]

Janetj- Nope. Market timing involves timing buy sell decisions based on some parameter. You are using up and down as your parameter. You are also using value when you are deciding what is over and under priced. How you determine 'value' is irrelevant... you're buy and sell decision is timing the market. FMF buys a % of his income every month in a market index. He blindly buys and redistributes the asset allocation of his portfolio. He is not market timing. Based on what you've told us, you are market timing. You are in fact guessing as you call it. To be specific, you are mean revert trading and if you use valuation, value investing.

[FMF]

Tyler --

I knew you weren't going to agree with her answer. ;-)

[John]

If you are really worried about the lack of returns in the US and the falling value of the US dollar, there is not a lack of other options. For example, there is always gold (GLD), though it may already have run its course; there is oil (USO); there are emerging market funds (such as EEM); and even an africa fund (NAFAX), and Barron's and Wall Street Journal both pointed to africa recently as the next hot spot for significant development and potential returns as the development in other countries have already been priced in.

[nick]

10 % now way not yet < in the next year depending of the gov

[frodo]

Actually, in my opinion, janetj is not guessing. I think we can all agree that the market is below where it was a few years ago - no timing involved to buy now. Good time to buy, no guessing involved. The only thing I disagree with janet is to try to figure out when to sell. I use the value cost averaging method which is a variation of dollar cost averaging. I never actually sell, but I just buy more when the markets are down.

[frodo]

In a way though if you think about it, everyone is a market timer. You decide when to buy and you decide when to sell (at retirement typically). Dollar cost averaging is actually a form of market timing - instead of buying everything at a single point in time and selling at another time, you are buying at intervals, betting that the average price is lower than the price at a single point in time.

[Old Limey]

Frodo
Actually there have been studies that have shown that "Great Fund Selection" beats "Great Market Timing".
There are many periods when the broad US market indexes are doing poorly and yet somewhere in the world (including the USA) there are some funds and fund categories that are doing very well.

Performing fund selection requires that you have access to a commercial database containing thousands of funds (currently 10,175) that are grouped into hundreds of fund families (currently 662). The database has to have the up-to-date price history (adjusted for all distributions) of each fund. You also need ranking software that allows you to search through this massive amount of data and then locate the very best performers based upon your particular selection parameters. In my case I like funds that are in strong, low volatility uptrends. The fund information currently contains 385MB of data and the family data another 5MB so this process requires a lot of computer number crunching and takes considerable experience so it's not for everyone, and obviously it's not free.
I have been a subscriber to such a database & software and using this technique since retiring in 1992 and have become pretty good at finding the best performing funds that meet my objectives. It sure beats using market index funds and has enabled me to have an annual rate of return of 18.3% since 1992 - it used to be quite a bit higher but I went very conservative at the end of 2007 and now that I'm 76 I plan staying conservative for the rest of my days.

[simoncow]

I have gained 30% per year by randomly picking stocks, but I'm simply lucky. Didn't even use a software program.

[Tyler]

Frodo- I wasnt saying she was guessing- she said market timing was guess and I said her 'rule' was a form of market timing. Thus, if she believes market timing is guessing, and her rule is a form of market timing, she is guessing. Again, her words, not mine.

I would agree the the US stock market is slightly below its all time high, but I would also agree the US stock market is above its 5, 10, 100 etc year low. Being above or below X doesnt really tell in investor valuable information. Enron was far below its high at one point.

Buying or selling based on a market based variable is by definition market timing. Using a valuation metric could be debated, but to me, it still has an aspect of market timing. Google market timing.

I am not arguing that her stated strategy is incorrect. My argument is that she utilizes a strategy which involves market timing and therefore she should be aware of the implications and adjust her expectations according. (For example, she will have a portfolio that will likely have additional volatility when compared to FMF.)