Stocks for the Long Term. What is “Long Term?”
Jan 16 2009
So you’ve heard it a hundred times. Only invest in stocks if you have a long term horizon. Here we are in this economic downturn and some of you nearing retirement are wondering, “What is long term? I have 5, 10, 15 years to go. Is that long term?” I have to share a little information to lead up to the answer.
Start with the fact that our economy goes through up and down cycles as a normal course of events. The cycle goes up when demand for goods and services goes up and the supply system kicks in to meet demand. Demand decreases and the cycle heads down because the need for goods and services decreases. We are currently suffering from exaggerated demand fed by easy credit and the lack of personal savings—the rally cry was spend, spend, spend! The economy overheated; AKA “the bubble.” This resulted in an overextended supply system as it worked to meet artificially high demand. We are feeling the pain as the supply system readjust to a normal state. Retail sells down, lower production, loss of jobs, higher savings, tighter credit… How long can it last?
“How long can it last?” and “What is long term?” are related. We are talking about economic ups and downs. The Gross Domestic Product (GDP) is a measurement of the state of our economy; economic growth or not. Consumer and business spending are significant parts of the GDP along with government spending and exports-imports. Typically the GDP increases 2.5 to 3% a year. So growth is the norm. That’s a good thing and indicates your investments are up more than they are down most of the time.
Here’s a chart of our GDP from 1930 to 2007 (I’m using 2007 because I have a full year’s data through that year):
Lots of positive and little negative. But when negative hits, and depending on the timing of when it hits in your life plans, it can be painful. The average GDP downturn, or recession, lasted 10 months. We are in the 14th recession since 1930.
Let’s compare the GDP chart with what happened during the same time period in the stock market as measured by the Dow Jones Industrial Average.
Because the stock market is driven by company earnings, the rather consistent nature of positive GDP growth drives nice growth in the stock market.
Come on Shane, what’s the answer! Well, of course it depends on several factors. Nothing is cut and dry. Are you still working? How long have you been working? How much have you saved? What is your allocation in your investment portfolios (401k/IRAs) between stocks and bonds? How many more years until retirement? Are you still contributing to your portfolios?
If you are still working and contributing to your portfolios, you will regain your “losses” quicker by having a majority stock portfolio and through consistent purchases during the down period. Your rebound time averages approximately one year for younger workers (< 10 years on the job) and approximately 2 years for more senior workers (> 10 years on the job). Buying while the stock market is low decreases the share price of your holdings by increasing the number of shares bought and owned at cheap prices. When the market rebounds, you don’t have to wait until the market returns to its pre-recession levels because you have lowered the bar, so to speak, with a lower average share price in your portfolio. What? If you buy a shirt for $30, your average shirt cost is $30. If you buy two more shirts at $10 each, your average shirt costs is now $16.60. If this was the stock market instead of shirts, to be back at even, the market would only have to climb back to $16.60 and not $30 to make you whole.
If you aren’t working and/or not contributing, your wait is longer. This is assuming you remain invested in stocks. Let’s look at this a couple of different ways.
First look. If you start the clock right now at your current account values, then, approximately 80% of the time you’ll be in positive territory after a 5-year period. You’ll have a 95% chance of a positive return over a 10 year period. And over 15 years you are virtually assured a positive return.
Second look. You want to know when you will be back to whole based on your October 2007 account value. No one knows the answer to this. Historically, it has taken up to 20 years after the Great Depression but usually it is less. If this is your objective, to be made whole the quickest way possible, you’ll need an outstanding stock picker–not probable.
For the future, all you workers must understand the economic cycles and how they affect your portfolio. If you are 10 years or less from retirement, note if we are rising or falling in the cycle.
If we are rising, start pulling profits off the table on the way up to lock in your gains. Don’t get greedy and ride the wave all the way up before you pull the profits. You’ll get caught as the cycle goes over the top and you will lose value fast.
If the cycle is falling, buy like there is no tomorrow. Decrease your average share costs and prepare for the rebound.
We’ve had two bubbles burst since 2000. We should have learned our lessons by now and know how to react. There are so many variables in this discussion that we can only hope that things go according to the norm. Then we somewhat know what to expect. Best wishes everyone.
Thanks to data and reports from the Dow Jones, Washington Post, Employee Benefit Research Institute, Department of Commerce, Bureau of Labor Statistics, U.S. Bureau of Economic Analysis, and American Funds.
I am probably on the wrong blog. Perhaps you can forward to the appropriate place.
Several years ago I recall MOAA advocating for long term health care insurance. When contacting MOAA, we were eventually transferred to Genworth and purchased two policies (my wife and myself). Out annual payments are due in a few days and I was curious what MOAA now thinks of Genworth and its long-term outlook. Does MOAA still endorse Genworth?
Understand the future is unclear but would you continue to invest w/ them?
Thanks.
Kenn Harris
Prior to coming to the MOAA staff, I worked for our insurance broker, Marsh, for almost 15 years; running the MOAA insurance program for most of that time. I can provide the following input on the situation with Genworth.
Many of you may be wondering if what happened at Genworth, our provider of Long Term Care insurance, has an impact on MOAA members. After several meetings and phone conversations with Marsh staff (our insurance broker) and Genworth headquarters staff in Richmond and reading various press reports, I believe it is fair to say that the insurance side of Genworth remains sound.
While Genworth was downgraded by one of the rating agencies (Standard and Poor’s), they are still an investment grade security and their headquarters’ staff maintains that they are financially sound and have a great liquidity position. Using AIG as an example, despite $1 trillion in assets, AIG was done in by a cash flow crisis because they had a very poor liquidity position. Genworth saw this eventuality coming their way and started positioning assets early to avert what got AIG.
Insurance companies are regulated by different government entities in this country (typically state regulators) and throughout the world. Although regulations vary by jurisdiction, insurance companies are subject to rules that establish:
? capital and surplus requirements
? restrictions on investments, and
? limitations on dividends and other distributions to shareholders.
Fundamentally, insurance regulations require that insurance companies maintain sufficient assets to pay their obligations to their insured population. The amount of capital and surplus required to be maintained is based upon risk-based capital formulas and is regularly reported to and reviewed by insurance regulators. Also, insurance companies are subject to regulations which are designed to encourage prudent investments. In every state in the U.S., for an investment to be considered a qualified asset on an insurer’s statutory balance sheet, it must meet strict requirements relating to size, rating and type. The parameters for valuation of investments are set by insurance regulators, not by corporate boards.
Holding companies that own insurance companies, Genworth, for instance, are very limited in their ability to utilize assets held by their insurance subsidiaries. Significant transactions by insurance companies with their own affiliates, including their holding companies, are subject to regulatory review and approval. Regulations such as these are designed to protect insureds in the event of a bankruptcy or reorganization of a parent of an insurance company.
re: long term investing.
The example for dollar cost averaging of buying of the three shirts, one at $30 and two at $10 for an average cost of $16.60 is arithmetically correct but misses an important point. If you have a large amount of stock and limited free cash for additional investment after the stock falls the plan doesn’t work very well.
re: long term investing.
The example for dollar cost averaging of buying of the three shirts, one at $30 and two at $10 for an average cost of $16.60 is arithmetically correct but misses an important point. If you have a large amount of stock relative to your available cash for additional investment after the stock falls, the plan may take a long time to significantly lower your average cost.
If you have 100 shares (shirts at $30) and your annual available cash is enough to buy 10 shares a year at $10 per share (which I would expect to be a more likely scenario than buying an additional 100 shares a year for the next two years), the average value that the stock needs to reach before you are above water is $28.18 after the first year, $26.67 after the second year, and not $16.60. Your example only works if you invest the total shares of your initial portfolio (one shirt in your example 100 shares in mine) each year.
Another example of this is, if your portfolio has decreased by 50% this year and your broker tells you to not to worry because it will be going up 50% next year, you should worry even if he is right, because, by losing 50% of your principal you will need to gain 100% in one year to get back to even. Arithmetic is; a $100 portfolio decreases by 50% leaving you $50. The next year it increases by 50% giving you a $25 gain or a total of $75. You will need another gain of over 30% the next year to approach your initial value of $100.