Being wealthy doesn't mean having all the money in the world, just not having to worry about it.

Lesson 13 – Stocks for the Long Run

Obviously, you cannot buy everything. Where would you put it? Also, not everything’s for sale. We need to limit our discussion, at least initially, to investments that are easy for the average person to make. We’ll begin with stocks.

I can’t predict the future. I can, however, do a reasonable job of predicting the past. Elroy Dimson, Paul Marsh, and Mike Staunton (henceforth known as DMS) are three professors at the London Business School who have been compiling data on the performance of stocks and bonds for 19 different countries going all the way back to the year 1900. These countries represented 89% of the world equity market at the beginning of 1900 and 85% as of the end of 2011. The return of a globally diversified portfolio over those 112 years was 5.4% above inflation, before fees and taxes.

Naturally, this includes the returns of countries that had relatively benign societies, such as the United States. It also includes Japan, which suffered a massive loss of wealth around the time of World War II, and Germany, which was clobbered economically during two world wars and had a mild bout of 4 trillion percent inflation in the early 1920s. (Fun Fact: While German bonds and bank accounts essentially lost 100%, German stocks rose 75% faster than inflation during the 1920s, providing a real return of around 6% per year. This is because stocks represent the real wealth of businesses providing useful goods and services.)

The case for stocks seems obvious. Over long periods of time, and in virtually every investable country, stocks have outperformed bonds and bank accounts. Of course, there is the short run. Oh, the painful short run! Recently, perma-bulls, like me, have been treated to many articles pointing out how well bonds have done relative to stocks over the past few decades. Some have even suggested that the advantage I’m deriving from the historical data is an artifact of an unusual century that isn’t relevant to the current one.

So, what about bonds? Give me a moment to think.