Monday, March 26, 2012

Do equities always outperform in the long run?

An interesting overview of the equity risk premium from the psy-fi blog.

A couple of key takeaways:

First a quote from Buffet:

Warren Buffett, as usual, looks at this differently. Taking a hindsight view of the twentieth century in US markets:
“To break things down another way, we had three huge, secular bull markets that covered about 44 years, during which the Dow gained more than 11,000 points. And we had three periods of stagnation, covering some 56 years. During those 56 years the country made major economic progress and yet the Dow actually lost 292 points.”

So, do stocks always outperform (in the long run)? No, they don’t. And don’t expect long-run market returns in excess of 7% going forward. It might happen, but it probably won’t.

A point I try to drive home in my classes is that the assumption that stocks will earn their historic average return is very optimistic.  I think investors should assume a 2% real return and plan accordingly - which in most cases means saving more.