Are stocks always best over the long run? We have raised this issue before. It's important because more participants in 401(k) and other self-directed retirement plans are being told the answer to a comfortable retirement is to "buy stocks and wait."
But the truth may not be that simple. Last year, as Pensions & Investments noted, Zvi Bodie, professor of finance at the Harvard Business School, argued in the Financial Analysts Journal that the risk of an equity portfolio rises over time. Conventional wisdom is that it declines over time. If the conventional wisdom were true, Mr. Bodie argued, the cost of hedging an equity portfolio would decline with the length of the hedge period. In fact, it rises.
Now James Paulsen, senior managing director, Investors Management Group, Des Moines, Iowa, has entered the fray. He argues stocks are not always best over the long run.
Mr. Paulsen notes that for the 126-year period from 1870 to 1995, stock returns exceeded bond returns by 400%. Pretty impressive. However, he notes, most of that outperformance occurred during just 20 years - the period between 1942 and 1962.
During the first 72 years, bonds provided returns almost equal to stock returns, and with substantially less volatility.
What was there about the 1942-1962 period compared with the first 72 years? Mr. Paulsen noted the 20-year period was one of abnormally strong real economic growth. In addition, inflation was largely absent until the post-1940s period.
Looking at 10-year periods since 1870, he found that from 1870 to 1940, real economic growth seldom exceeded more than 2% per year, while after 1940 it rarely has been less than 2%. The difference is most apparent between 1942 and 1962, a period of "record-setting outlier growth," according to Mr. Paulsen. He notes economic growth has been subpar thus far in the 1990s. The questions he now asks are: Will growth remain subpar for the remainder of the 1990s? Will inflation remain benign?
Let me add: Is the current decade more like the 1942-1962 period, or the 1870-1940 period?
At least superficially it looks more like the latter. The 1870-1940 period was one of great technological advancement that increased human productivity on farms and in factories. There were advances in transportation and communication. Old job categories disappeared, and new ones were created. There were long periods of excess supply and weak demand.
If this analysis is correct, and if Mr. Paulsen's analysis is correct, for the next few years bond returns might match or better stock returns with less volatility.
It seems the whole question of the relationship between long-run stock and bond returns might be a fertile field for further academic research. Its surface has barely been scratched in the studies by Roger Ibbotson, Rex Sinquefield and Jeremy Siegel.
Meanwhile, perhaps more caution is called for in urging employees to push up the equity allocations of their 401(k) plans.