Hold stocks for the long term. They'll always do better than bonds or cash. In the long run, stocks are safe.
That's dogma in today's Church of Wealth. But allow me to disagree. As a challenger, I want to know what you mean by "stocks," what the "long term" is and what you think is "safe."
Historically, the market clearly favors stocks. Over 65 10-year periods since 1926, the Standard & Poor's 500-stock average lost money only twice, and those were in decades around the Crash of 1929.
Over 60 15-year periods, stocks made money every time, according to Ibbotson Associates in Chicago.
But you have to weigh these facts against a couple of caveats.
First, they assume that you reinvest all dividends. If you spend your dividend checks, as some investors do, you wouldn't have come out so well.
Also, the performance data isn't adjusted for inflation. So they overstate the purchasing power your investments yield.
After inflation, stock investors lost money in seven of the 65 10-year periods studied. That's 11 percent of the time. There were even two 15-year periods that fell behind.
There's also a higher chance of mediocre returns than most people realize. In 20 of those 15-year periods, stocks returned 5 percent or less, after adjusting for inflation. So long-term investors had poor returns 33 percent of the time.
All of the losing periods, and most of the punk ones, ended in the mid-1970s to early 1980s. Since then, life has been grand.
So here's another little fact to tuck away. Historically, super years for stocks have followed years when the market was excessively undervalued. It was undervalued in the 1970s; in 1984, prices began a huge bull run.
Conversely (and this is the bad news), punk years for stocks follow years when prices have been extremely high. They appear high now. That suggests lower average returns in the years immediately ahead, although one never knows.
This brings me back to the question of whether stocks are safe enough, if held for the long term.
First, what do you mean by "stocks?" Yes, the market usually does well over 15-year holding periods. But that measures the S&P index of 500 leading stocks. You get different results when you own a small collection of individual stocks.
Maybe your stocks will do better, maybe they won't.
Although markets always recover from slumps, individual stocks may not.
You cannot automatically buy and hold individual stocks. You have to review them all the time. Are they still growing? Are their profit margins under pressure? Has unexpected competition shown up?
You can buy and hold an index mutual fund that invests in the market as a whole. But individual stocks have to be sold from time to time, and it's not easy to pick the right time.
This brings me to the next question, what do you mean by "long term?" Will you keep on investing in stocks or stock funds (inside or outside a 401(k)), if the market does badly for a couple of years? Or will you move to the sidelines and wait?
If you sell when prices drop far enough to scare you, then buy when they've risen enough for you to be reassured, it's pointless to talk about the market's successful long-term record. You're not going to get it because you didn't stick long-term.
Investors in well-diversified mutual funds are better off in the market than out, says Clay Singleton, Ibbotson's vice president for asset allocation. Stock market gains come in sudden clumps - a big month or two, followed by flat or down months. You can't guess those big months in advance.
Now the final question: what do you mean by "safe?"
The longer you hold well-diversified stocks, the smaller the risk that your portfolio will lose money.
If you hit one of those rare runs of bad luck, however, your loss could be large. In this sense, stocks are risky over the long run, as well as over the short run.
That's why cautious investors keep a portion of their money in bond funds and cash, especially as they approach retirement. They don't want to bet their standard of living on always getting stock prices right.