“The future ain’t what it used to be.” – Yogi Berra (and, apparently, lots of other people).
Yesterday, we talked about long-term returns from the U.S. stock market and discovered that, if you factor in the days when America was an emerging economy, long-term returns were bad for a long, long time. What can we say about long-term international returns? Mainly that we have been very, very lucky to live in the United States.
“A Century of Global Stock Market Returns,” by William E. Goetzmann and Phillipe Jorion and published by the National Bureau of Economic Research, looked at stock market appreciation indexes from 39 countries with returns going back to the 1920s. At the time the paper was written – 1998 – the U.S. had an inflation-adjusted annual return of 5%. The rest of the world had a median annual gain – half higher, half lower – of 1.5%. Of the 39 countries examined in the paper, not one had higher stock returns than the United States.
Long-term returns for the rest of the world are hard to come by, in part because of war and political upheaval. At the start of the 20th century, one could have made a compelling argument that Argentina would be a dominant economy in the Western hemisphere, if not the dominant economy. One would, of course, have been very wrong.
You could have made compelling bets on other active stock markets at the time, which included Russia, France, Germany and Japan. All of those markets not only ceased operations during World War I or II or both, but saw catastrophic losses, both in terms of currency and actual market value. War is only good for the economy if you win, and if you fight on someone else’s territory.
Of the 21 markets which have data back to the 1920s, only six had no interruption in operations – the U.S., Canada, the U.K., New Zealand, Sweden and Switzerland. For many countries, a buy-and-hold strategy was simply a matter of how much money you wanted to lose. “By now, however, it should be clear that if we fail to account for the “losers” as well as the “winners” in global equity markets, we are providing a biased view of history which ignores important information about actual investment risk,” the authors conclude.
So what can we learn from all of this largely gloomy data?
- It’s important to keep an eye out for things that can cause a permanent loss of wealth, particularly as you grow older. William Bernstein, author of Deep Risk, argues that those risks are inflation, deflation, government confiscation, and geopolitical disaster.
- Few people see these events coming, although there is a permanent community of advisers who always see those things coming. Try to ignore those people.
- Keep a highly diversified portfolio. I like (and own) Vanguard Total World Stock Index (VTWSX) because it’s cheap (0.17% expenses) and ridiculously diversified. For those who don’t feel like figuring out how much Swedish stock to own, the fund takes care of the issue for you.
- Indexes aren’t as passively managed as you’d think, and to some extent, that helps. Should the U.S. fall into a Japan-like trance, your world index fund will see U.S. holdings fall, relative to more vivacious ones. It’s not a perfect system, but unless you want to actively manage active managers, it’s not bad.
- Hold your nose and own some government bonds, which are your best defense against deflation. When prices fall, interest-bearing debt becomes more attractive, and government bonds are less likely to default than, say, bonds issued by newspaper companies
- Hold your nose and own some cash, so you won’t have to make withdrawals during a down market. You’ll also have money to invest when stocks or bonds are cheap. (They aren’t now).
- Rebalance when your target allocation between stocks, bonds and cash are out of whack – say, ten percentage points more than you wanted. If you wanted 60% of your portfolio in stocks and you now have 70%, sell enough to get back to 60%, and invest the proceeds in your lagging assets. (It doesn’t hurt to simply do this annually).
- You can be more aggressive when you’re young and adding to your portfolio regularly. If you’re older and retirement is looming, you’ll need to be more conservative, because you won’t be able to recover as quickly. Investing, like running, is a lot more fun when you’re young. And if you’ve reached the amount that you need to retire, you really don’t need to take any more risk. The idea is to keep your money, and not die broke.