A Get-Rich Slowly Scheme

A Get-Rich Slowly Scheme

Consider the case of Louie the Loser: stocks made him a winner

Buy low, sell high, it’s a dream of all investors hoping to strike gold in the stock market. The strategy sounds simple enough, but, as most investors know timing the market is elusive at best. Now it turns out timing may not matter much after all. Analysts at Capital Research and Management Co, a mutual fund company, created Louis the Loser, an investor with the world’s worst timing. Every year for twenty years Louie pumped five thousand dollars into Investment Co of America, an actual fund managed by Capital Research. Each year Louie invested at the worst possible time – the day that the Dow Jones average hit its peak for the year.

How did Louie fare? He was hardly a loser. After twenty years, Louie’s $100,000 grew to $441,000 – a respectable average annual return of 13.3 percent. By comparison, if a Willie the Winner had invested $5,000 a year on the day the market hit its annual low, he would have shown 14/9 percent return, only slightly better than Louie’s. Small wonder that shrewd investors, like Warren Buffett, advise ignoring the day-to-day gyrations of the market, preferring a simple buy-and-hold strategy for stock investing.

When devising your overall investment strategy, the best approach is to allocate your money among different investments, based on factors like your age, income and when you’ll need the money. To manage the risk of stock market ups and downs, a basic buy-and-hold strategy known as dollar cost averaging can help. By investing a set dollar amount regularly, say $200 once a month, you get more shares when stock prices are low and fewer when prices are high. Over time, the strategy reduces your average cost per share, improving your chances of becoming a slow but steady winner.

New York. Photo by Elena

History shows that stocks are sturdy. Measure stocks against bonds, cash in houses, oil, gold, or in collectables like stamps and diamonds, for example, is considered smart during times of high inflation, which can hurt stocks and bonds. But not over the long haul. After tracking the returns of different assets, R.S. Salomon Jr, founder of the Stamford, Conn. Investment management firm STI Management, found that returns on tangible assets fluctuate wildly from year to year. Silver may be hot one year, farmland the next. But in the long run, financial assets – bonds, stocks, even plain old cash – beat out collectibles and hard assets. This exercise proves that how you allocate your portfolio among broad categories is important, probably more so than which stocks or bond or hard assets you buy.

What happens if you pit stocks against cash over the long term? Again, stocks are tops. A cash investment is money invested in three-month Treasuries or a first-rate money market fund, not the emergency reserve you keep on hand for a rainy day. Looking back 50 years, cash has beat out stocks only 10 times, according to Ibbotson Associates. One of those rare periods was between August 1983 and the end of 1984, when the returns of the 30-day Treasury bill outperformed the Standard & Poor 500 stock index by three percentage points and the 20-year Treasury bond by 15 percentage points. Usually, though, periods when cash is king have not lasted longer than 24 months. Over the long term, cash has been a loser. After accounting for inflation, cash has returned an average 0.5 percent per year since 1926, compared with 6.9 percent after inflation for the S&P 500, according to Ibbotson.

How about stocks versus bonds? You could compare returns of small company stocks, large company stocks, long-term government bonds, U.S. Treasury bills and inflation going back to 1926. Assume you invested $1 in each of the four instruments at the end of 1925.

Through wars, depressions, bouts of high inflation and recessions, oil embargoes and market crashes, that dollar would have grown most if you had invested in small-company stocks. It would have ballooned to about $5,000 by now. By comparison, a $1 investment in ultra-safe Treasury bills would have returned a mere $20 (these number assume income from the investments is reinvested and do not consider commission costs or taxes).

Together, returns on large and small company stocks averaged 11.3 a year. Long-term Treasury bonds did less well, yielding an average 5.02 percent. Bond yields generally don’t match stock returns in the long race, but then again, bond investors experience fewer hairpin turns than stock market riders.

Is the past prologue to the future? Many investment analysts seem to think so. Some investors steer clear of consumer stocks and move toward bank and other financial stocks. Some other like economically-sensitive stocks such as airlines, railroads, paper companies, electronic manufacturers, and other technology stocks. We can strike a cautious note, however: Stocks and bonds are sometimes overreacting, and odds are they will underperform in the future. If so, the Louies and Willies may have to muster a bit more patience