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Stocks and the Long Run

BERKELEY – After the second 40% decline in America’s Standard & Poor’s composite index of common stocks in a decade, global investors are shell-shocked. Funds invested, and reinvested, in the S&P composite from 1998-2008 have yielded a real return of zero: the dividends earned on the portfolio have been just enough to offset inflation. Not since 1982 has a decade passed at the end of which investors would have been better off had they placed their money in corporate or United States Treasury bonds rather than in a diversified portfolio of stocks.

So investors are wondering: will future decades be like the past decade? If so, shouldn't investments in equities be shunned?

The answer is almost surely no. At a time horizon of a decade or two, the past performance of stocks and bonds is neither a reliable guarantee nor a good guide to future results. Periods like 1998-2008, in which stocks do relatively badly, are preceded by periods – like 1978-1988 and 1988-1998 – in which they do relatively well, and are in all likelihood followed by similar periods.

Do the math. At the moment, the yield-to-maturity of the ten-year US Treasury bond is 3.76%. Subtract 2.5% for inflation, and you get a benchmark expected real return of 1.26%.