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Author: yttire Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 464868  
Subject: Questioning stocks Date: 12/8/2011 8:02 PM
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Over the last 30 years, bonds have beaten stocks, but barely.

This means, in the grand scheme of things, that bonds and stocks have been fairly efficiently priced. The long term yields of both are almost exactly the same. It is almost as if the investors over the past 30 years saw into the future over many decades, and the price of the vast swath of potential investments ended up equalizing into a perfectly efficient market.

Or did they?

Over that same time frame, the immediate value of any particular stock holding fluctuated wildly.

In other words- the two asset classes yielded the same return yet the stocks were much more volatile and carried more risk because of this

Yet the stock investors were not compensated for this risk. The only thing they did was buy risk, and get no return.

So then the question must be- what is the point of buying stocks in the first place, if they carry more risk, but generate the same returns over long time periods?


I listened to an investment advisor pitch and the one thing he pointed out that stuck in my craw was the notion that the expected future return of stocks will not be a lot higher than the expected return on bonds. Therefore, one should not be heavily invested in stocks, because the risk reward trade off is not worth it.

His point was that one needs to figure out a target amount of money to save towards, and then adjust the risk profile downwards to take on the minimum risk while maximizing the chances of meeting the goal. If you are falling far short of your goal, then you must by necessity expose yourself to more stock market movement in the hopes of capturing a higher yield.

For if we go further than 30 years, say 50 or 80 years then the stock market again beats the bond market.

So essentially, an investor who has a smaller pile of cash is forced into larger and larger stock exposure, in the hopes they do not live in the many decades where stocks and bonds performed the same, or stocks performed worse- because all they are doing is exposing themselves to massive risk on the hopes they live in some benign decades for investing.

In this upcoming decade, with record amounts of debt, completely ignoring the possibility of bank default and political collapse (which are both real risks), an investor in the stock market is simply assuming a lot of risk with the expectation that this exposure may actually simply be risk, and no reward.

An enthusiast for taking on risk would point out- but bond yields are so low.

But the response to this is:

The stock market has been rationally priced for the last 30 years, and in fact, it is rationally priced now..

This means that in effect, much of the earnings we are observing are being discounted, but the investor population as a whole is assuming upcoming economic malaise. The earnings are not as good as they seem, because bankruptcies, shrinking consumption, and a downward business cycle are in the future. If the market is efficiently priced, then the low bond yields without an upwards motion in the stock market is reflective of a poor economic future.

So a stock investor is actually merely taking on risk without reward. Caveat emptor.
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