Case Closed: Stocks Work

THIS YEAR MARKS THE 30TH ANNIVERSARY of a famous Business Week cover story "The Death of Equities." Along with those scary words, the magazine's Aug. 13, 1979, cover read, "How inflation is destroying the stock market." But starting around that time, investors could have beaten inflation quite handily by snapping up stocks and holding them for five or 10 years.

Buying the stock market at the close of 1979 would have yielded, after inflation, an average annual return of 7.3% over the next five years. An even higher five-year return of 9.47% could have been captured by going long at the end of 1978. The 10-year performance would have been healthier still, yielding 9.52% or 10.75%, depending on whether the investor bought at the close of '78 or '79.

With the stock market in the throes of yet another near-death experience, another rebirth could be in the offing. Five- and 10-year returns on stocks through year-end 2008 have run negative, and would have looked even worse at the lows of last week. But based on the historical record, performances like these bode well for the next five to 10 years.

THE HISTORICAL RECORD SHOWS that for 20- and 30- year periods, inflation-adjusted returns on stocks have never been negative. Over the 137 years from 1871 through 2008, returns after inflation for 20- and 30-year intervals have been consistently positive. Median returns over the 20-year intervals have been 6.85%, and for 30-year intervals, 6.23%.

With this consistently strong performance over long periods, it stands to reason that below-par returns over five- and 10-year intervals would tend to be followed by much better results over the subsequent five- and 10-year intervals. And in fact, the historical record shows that, following below-average returns over five and 10 years, subsequent periods of similar length do tend to perform better than average.

An investor whose retirement is drawing near might take heed: Investing in stocks today could help produce the cash you will need five or 10 years down the road.

Those who plan to retire in less than 10 years would benefit if the historical trends hold true. Positive returns over the next 20 or 30 years would only make retirement more of a breeze.

Critics of stocks as vehicles for retirement often rig their case by assuming that investors entered and exited with the worst possible timing, buying at peaks and liquidating at bottoms.

But diversification over time -- buying and selling periodically, rather than all at once -- can be quite effective. Most investors would be foolish to liquidate all their stock holdings on the day their retirement begins, unless they feel endowed with timing skills that few can claim. If they plan to live 20 years past their retirement, they might plan to hold on to at least part of their holdings for 15 to 20 years.

And of course, retirement accounts are set up in such a way that buying can occur in installments over many years. The acquisition of stocks can therefore be diversified over time, along with the process of liquidation.

From this perspective, useful insights can be gleaned from the exhaustive record originally pieced together by Wharton School finance professor Jeremy Siegel for his best-selling book, Stocks for the Long Run, now in its fourth edition.