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I HAVE NO IDEA HOW stocks will perform this year or next. But I have full confidence that a globally diversified stock portfolio will fare just fine over the decades ahead.
My optimism, it seems, isn’t shared by many HumbleDollar readers, who fear we’re facing some rough years for the economy and the stock market. How do I justify my optimism about the long term? Here are five reasons.
1. Heads I win, tails we all lose. As I’ve noted before, I view betting on the stock market as an asymmetrical bet. If all goes well, stocks win. If things go terribly, all investments could potentially lose—bonds, cash investments, alternatives, you name it. If we get economic apocalypse, nobody’s going to want your American Eagle gold coins, and they certainly won’t want your bitcoin.
To be sure, the future isn’t limited to two alternatives, either continued economic growth or economic apocalypse. Conceivably, the economy could stagnate, generating no long-term growth. In such a scenario, holders of bonds and cash investments might still get paid, even as stocks plunge in value. Still, while it’s entirely possible that we’ll have a brief period of no growth—after all, real GDP shrank in 2009 and 2020—I think it’s highly unlikely this would continue long-term. How can I be so sure? That brings me to my next point.
2. Humans strive relentlessly to improve their lot in life. When Hurricane Irma hit the Florida Keys in 2017, 25% of homes were destroyed and another 65% suffered major damage, according to the initial assessment by the Federal Emergency Management Agency. Did residents give up in despair? Far from it. Three years later, when I drove down to Key West with my sister, the Keys were back to business as usual.
But perhaps my favorite example is 2020’s pandemic. Not only was it astonishing how fast a vaccine was developed, but also businesses large and small adapted with remarkable speed to a world where folks were leery of close contact with one another. Welcome to Zoom calls, online Peloton classes, outdoor dining and contact-less payment systems.
3. If the economy keeps growing, stocks should keep rising. Vanguard Group founder Jack Bogle would occasionally offer his forecast for U.S. stock market returns over the next 10 years using three inputs: starting dividend yield, expected growth in earnings per share, and changes in the market’s price-earnings (P/E) ratio.
Along those lines, suppose we add today’s S&P 500 dividend yield of 1.4% to the 6.7% annualized growth in earnings per share for the past 10 years. Result? We might be looking at stock market returns of just over 8% a year. But what if investor sentiment turns sour, driving down today’s lofty P/E ratio of 28?
Let’s say the S&P 500’s P/E falls to 20, which is the 50-year average. If that happens over 10 years, it would knock 3.3 percentage points a year off the market’s total return, leaving investors with some 5% a year, slightly better than today’s 10-year Treasury notes will deliver. What if this “multiple contraction” takes place over 20 years? The annual hit would be 1.7 percentage points.
The lesson: Investor sentiment isn’t that important to long-term investors, and the longer your time horizon, the less important it becomes. Instead, what matters is growth in earnings per share. As long as the economy keeps humming along and investors hang tough, they should fare just fine.
4. If the economy malfunctions, the government will pull out all the stops. Have you heard that it took 25 years for the Dow Jones Industrial Average to return to the high notched in 1929, just prior to the Great Depression? If you calculate after-inflation returns and include dividends, it turns out that investors who bought at the 1929 peak would have broken even by late 1936.
More important, the economic hit could have been shortened and softened if politicians and policymakers hadn’t initially pursued tight fiscal and monetary policies. Those policies made the Great Depression so much worse. Today, by contrast, politicians and policymakers may not get it exactly right, but they have a far better idea of how to handle such situations.
In his book Deep Risk, Bill Bernstein points to four such risks—deflation, inflation, confiscation and devastation. These are Bernstein’s four horsemen of the economic apocalypse, all of which could do major, permanent damage to your portfolio. Confiscation and devastation—think an overthrow of our democracy or war on U.S. soil—could destroy the value of all investments, whether stocks, bonds or cash. In such scenarios, not much would help beyond an ample supply of food, fuel and ammo. A well-stocked wine cellar might also come in handy.
But what about the other two risks, deflation and inflation? The folks in Washington are keenly aware of both. In late 2008 and early 2020, they moved quickly to head off the risk of deflation. In 2022, they again moved decisively, this time to throttle escalating inflation. All three episodes were a messy business, and clearly 2022’s inflationary surge hasn’t yet been fully stamped out. But without Washington’s intervention, it would have been a whole lot worse.
5. It’s a big world—fortunately. In February, Japanese stocks notched an all-time high for the first time in 34 years. The country’s painfully protracted bear market isn’t a reason to be fearful of the Japanese market. Rather, it’s a reason to avoid investing heavily in any one country’s stock market.
That’s why my core holding is Vanguard Total World Stock Index Fund (symbols: VTWAX and VT), which replicates the global stock market’s weightings and currently has some 38% in foreign stocks. To many U.S. investors, that seems like far too much abroad. To me—faced with the slim possibility that the U.S. could suffer its own protracted bear market—it seems like it might be too little. But I’m not inclined to stray from the global stock market’s weightings. I may be an optimist—but I’m not optimistic that I can outguess the financial markets.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on X @ClementsMoney, on Facebook and on Threads, and check out his earlier articles.
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Warren Buffett once wrote “For 240 years it’s been a terrible mistake to bet against America, now is no time to start”. Total return from investment in S&P 500 from 2012 to 2022 is 2 to 4X the returns compared to MSCI Emerging Markets Index, MSCI Europe Index, and MSCI EAFE Index. Could this change now? Possibly, but may not be for long. There are many reasons such as superior innovation, strong brands, IP, and productivity. In essence, capital employed in US stocks provides better returns. With AI driving the next innovation cycle, this trend will likely continue. So being overweight in US stocks is not a bad strategy.
Sundar Mohan Rao
Simple, optimistic and pragmatic has worked for me. We just retired at 57. I believed that markets would return their average over 30 years with ups and downs along the way. That pretty much happened and then some. Dollar cost averaging, annual rebalancing, and age-20 in bonds served us very well. Now I’m at 57/43 in perpetuity. I made a 10 year rolling Treasury ladder yielding 4.8%, have most of my equities in VTI with about 5% stocks that I’ve owned for a while (they’ve gone up about 6x in 6 years and I’m still holding). I know I would make more being 70/30 or 60/40, but this allocation provides yields that almost cover our yearly spending. I’m good with that. Maybe at 70 I’ll start investing more in equities for my kids. It’s easy to get caught up in minutiae but very good shouldn’t be the enemy of great.
We have all of our Roth holdings (about 4% of total portfolio) in VT (Vanguard Total World Stock Index Fund ETF) which is in this fund for our children’s tax free inheritance.
I’m a believer in international diversification. But my question is:
41% of sales in the SP 500 are from foreign sales.
How does affect your thought process in determining allocation to international markets?
Ask yourself this: If the international sales of U.S. companies make them effective proxies for owning foreign stocks, why has the performance of U.S. and foreign stocks been so different?
I think I see your point.
1. There’s a strong US home bias and investors overpay because of it (higher valuations you mentioned).
2. Non-US companies selling within their own countries are materially different than US foreign sales, adding to diversification.
Follow-up question:
If you have the S&P with 41% foreign sales, and you add the market weight of 38% International; does that make you overweight in International?
Shouldn’t you also factor in the U.S. sales of foreign companies?
Incidentally, if U.S. investors pay too much to invest at home, the same could be said for comfort-seeking investors in other countries. Thus, I doubt that’s the reason U.S. stocks are more highly valued by standard metrics. Instead, I’d contend that the higher valuations mostly reflects the nature of U.S. stocks — they’re more likely to be growth companies and possess substantial intangible assets (brand names, intellectual property), and thus likely to carry higher valuations.
I don’t think you got the right lesson from covid. Whatever ‘astonishing’ thing that was developed in record time was not a vaccine, but something that made millions of people sicker than the disease it was supposed to prevent, and killed and disabled others, without preventing the disease. Then governments and corporations coerced people into taking it, in violation of the Geneva Convention.
This was after they had ruined small businesses, made children stay at home from school and wear masks, and damaged the emotional health of almost everyone.
The ability of governments to do harm is limitless, and what we saw with covid was just a demonstration. They are looking for an excuse to do it again in the name of ‘health’ or ‘climate’ or anything else. That is a massive risk.
Charles…Simply stated…Never have truer words been spoken.
What was most astonishing was that shutting down the economy was proposed as a way to stop a virus, and just selective parts of the economy at that.
Yes, quite true. Churches were shut down to prevent the virus, but not liquor stores. People were not allowed to be with their dying relatives, but rioting in the street was fine.
I’ve notice my comment and your reply are not popular, however, nobody had pointed out where we are wrong.
There’s a reason folks haven’t responded: HumbleDollar is a personal-finance site, not a site for political commentary. HD has a tradition of civil discourse on financial topics — and, thank goodness, the vast majority of readers respect that tradition.
Charles comment was civil, and it was 100% true as well. You may believe differently, and although we are all entitled to our own opinions, despite the attempts by some to cancel those with whom they disagree, we are not entitled to our own facts.
I believe you’ve missed the point again. You saw the development of the ‘vaccines’ as an example of resiliency. I see it as a ‘massive risk’ of government domination. My comment was a political as yours.
What’s wrong with deflation? Your money gains value. I’d rather have that than the 2% stealflation goal the Fed has. 2% inflation over 20 years, your money is worth 40% less. Back in the 60’s the price of gold was somewhere around $25 an ounce. Not because there was more gold around but because the dollar was worth that much more. I’d like to see the Fed change their policy to that of the German Fed, which is to maintain the value of the currency, not weaken it.
I do agree with you Jonathan, and after reading a lot of investment books, owning a diversified portfolio of stocks is the best overall investment, which on average will beat inflation.
In a deflationary environment, consumers hold off spending because they know prices will be lower next month. That kills economic growth and results in mass unemployment — which is what we saw in the 1930s.
I agree. 62% in US markets scares the heck out of me. And I know all about past performance results. Just do not like to break two of my key rules of investing: A. Do not try to time the market B. Diversify, diversify, diversify.
Insightful as always, but curious with regards to your third point. If P/E should trend down to a historical 20 (understanding that past performance is no guarantee of a future P/E), if the end result is a return of ~5% rather than an ~ 6.7%, wouldn’t that likely be viewed by many as worth the risk, relative to a treasury return?
While stocks will have outperformed Treasurys, I suspect many would be somewhat disappointed, given the greater risk involved.
Really?
The Florida home owners insurance market is in a crisis. “Since 2017, eleven property and casualty companies that offered homeowners insurance in Florida liquidated.”
It’s getting so expensive to insure a home in Florida that people are leaving the state.
Not relevant to this discussion, but auto insurance is much higher than average in Florida as well. The only thing good in Florida is the weather during the winter months. Their summer months (heat & humidity) are as intolerable as the cold in winter.
I wasn’t talking about the insurance market — something which, strange to relate, one can’t see from the road. Rather, I saw no damaged or destroyed homes,
As booch notes, people are indeed leaving the state due to dramatically rising homeowner’s insurance. A recent review also revealed that a substantial percentage of homeowner’s are opting to roll the dice and not insure their home.
So after the next hurricane, you may see something very different a year or two after the storm!
There are bears…and then there are bears. I think what you’re saying is that you’re not currently scared of bears, which is appropriate for someone living in urban Philadelphia, and you’re not going to change your investment strategy based on the possibility we are going to hell in a hand basket. (Where did that metaphor come from, anyway?)
I agree. I also am not scared of bears, although there has been one in our neighborhood this last winter. We keep our trash cans in the garage and compost….
[My favorite google thread on the origin of going to hell in a handbasket? Dante’s Inferno. No, I haven’t read it.]
Great article
I know you increased your equities during previous downturn some time ago. Did you rebalance back to 80% when the market recovered and reached new highs? Do you recommend buying the current dip?
Anything less than a 5% drop is business as usual for the stock market.
As I have written previously my plan has been to buy an extra 1-2% at market corrections (10% off of the last market all time high), 15%, decline, and a bear market (20% correction), then sell the gains in increments at the same levels as the market improves. This philosophy made me a fairly good sum without feeling like I was being greedy during the COVID crash.
I only “over-rebalance” when the market takes a steep drop, so I haven’t bought during the current modest dip. I’ve moved modestly more into bonds, but I’m still above my 80% stock target. That’s largely driven by the fact that my full retirement date seems to keep getting pushed further into the future, so I don’t foresee spending from my portfolio for at least a few more years.
Nice article, Jonathan. I’m in agreement on keeping it simple, and inexpensive. I have zero ability to predict the future, but I’m generally an optimist, so I’ll stay invested.
The adage, “Plan for the worst, & hope for the best” is my modus operandi. Thank goodness we were good savers as it’s going to be a bumpy ride in the world for awhile.
Especially if we become a dictatorship
Yes, it’ll be a bumpy ride. But when has it been otherwise?
Alfred E. Neuman famously said, “What, me worry?” Who would have thought Mad Magazine had an investment philosophy? (smile) To the best of my ability I try to follow that philosophy. My mother was an investor who went to the bank to borrow money in 1974 to invest in the stock market. It was a terrible, terrible year for the economy. There were a lot of problems and they looked almost insurmountable. But mom had faith in the United States. I think I inherited that from her. Thanks, mom.
After I reached a certain level of maturity (and I’m not talking just about age) optimism is what got me to where I am today. I’ve had ups-and-downs, but so has everyone else. I’m optimistic and hopeful on a wide range of topics, including finances.
I may be wrong, but I believe Humble Dollar readers are significantly older and moe affluent than the average American. We most likely have larger portfolios and lower if not no debt due to being frugal. Frugal people are better able to discern between wants and needs, and what expenses are necessary for survival. Those that would be in the worst predicament come a financial armageddon are the consumption oriented Americans.
Thanks for sharing your thoughts, Jonathan.
What is your current thinking for a typical retired person at age 80 portfolio be for the allocation in stocks, bonds and cash?
Is your “typical” retired person investing for themselves or for their heirs, what’s the state of their health, and do they have guaranteed income to cover much or all of their costs? My mother is almost 85, in great health and has her living costs comfortably covered by pension income, so she’s investing for her heirs — and has an allocation to stocks that rivals mine.
Well, Mr. Clements, there are two major issues which maybe game-changers.
We have apparently finished a 40 year cycle of declining interest rates from high double digits to near zero. This 40 year bond bull market has been the backdrop for every investor alive, so it feels like a normal state of affairs. Now at almost 5% up from near zero, everything must be re-priced with a new hurdle rate. You can already see the effects in the commercial real estate market. We also know when we pay for higher valuation, we get lower future returns.
At the same time, a debt cycle has risen from near zero to Trillions. Many economists have argued when debt exceeds 100% of GDP, the economy will struggle to produce growth. Now think about personal and corporate debt.
My thoughts are investors need to pay attention, the macro environment has changed radically, unlike any living investor/portfolio manager has experienced. The question is how shall our portfolios change?
Submitted for your consideration :
Consider a Japanese worker who started working in 1980.Assuming a 30-year career & $1K annual investment into Nikkei 225,by the time he retired in 2010, the $30K invested would have turnedinto $20K. A -31% return over 30 years.https://www.marketsentiment.co/p/how-safe-are-stocks-in-the-long-run
It is certainly true that the era of declining interest rates is over, but that doesn’t necessarily portend struggling stock markets in the future. If the hoopla surrounding artificial intelligence is even partially correct, the increases in productivity and efficiency made possible by this new technology should significantly reduce the costs of doing business which, in turn, should contribute to higher earnings. And, as Adam Grossman has written, those higher earnings should lead to higher stock prices.
Yes, declining interest rates were a tailwind for the stock market. But I would argue that factors of greater significance are innovation and free market capitalism. I’d say the odds are quite good that the stock market will be higher ten years from now. I’m not considering any significant changes to my portfolio.
Regarding commercial real estate, isn’t the pain felt in that market due more to half-empty office towers in the wake of the trend to remote work, rather than just higher interest rates?
The two issues you mention are concerning, but investors are also well aware of them — and presumably today’s share prices already reflect them.
I understand the “smart market” hypothesis which says that stock and bond prices reflect millions of investors digesting all available information and making their investment decisions accordingly. That may hold up in the very long run but if you are investing today with a 10 to 20 year outlook (assumes you are retired) and you don’t have any significant guaranteed income it is hard to justify the risk associated with a 70% allocation to stocks. I tend to agree with Troutbum52’s comment that we don’t know what the effect of the continuing growth in US debt will be, it cannot continue indefinitely.
I think John Bogle said your investment allocation should be whatever helps you sleep well at night!
Good thought-provoking article as always!
Bill
Instead of VT, which has an expense ratio of 0.07 percent, I suggest a mix of VTI (expense 0.03%) and VXUS (expense 0.08%). You’ll get the same global coverage, roughly, and save a few hundred dollars a year on fees.
And VXUS in a taxable account will get you a foreign tax credit.
The “default” option of many investors of putting foreign funds inside a taxable account solely in order to receive a foreign tax credit may not be in their best interest.
You would be better off tax-wise by having them inside an IRA wrapper if your US tax savings by having the fund inside the wrapper outweighs the foreign tax you would otherwise have credited to you without it.
One key metric to look at in your foreign funds is the differential between the in-country withholding tax rate on that foreign source income that the fund is subjected to vs. your personal tax rate.
For this reason, aside from the simplicity cited in the article, I have included foreign funds inside a Roth,
You’re right. But as I’ve noted in earlier articles, for me, it’s all about simplicity.
https://humbledollar.com/2024/03/totally-your-choice/
Very good.
If you are correct, as you most likely are, that your “optimism, it seems, isn’t shared by many HumbleDollar readers”, it explains why so many investors’ returns lag the overall market’s: they let sentiment get in their way, trying to time markets, chose sectors, and generally thinking they can figure it all out. They can’t.
Buy the haystack, and leave it alone.