Stocks: The Best Investment Vehicle?

One of the ongoing debates in the world of personal finance is what is the best investment option: stocks, bonds, treasuries or commodities? The answer, I believe, depends on personal risk-tolerance and circumstances. For money that is needed for at least five years, the best option may be an intelligent investment in the stock market.

Perhaps the most comprehensive evidence I have seen is the research by Wharton Professor, Dr. Jeremy Siegel. In his book, Stock for the long run, Prof. Siegel compares the returns of different assets over the last two centuries (yes, you read that correct). See below Table.

Time: 1802 - 2001
Not adjusted for inflation
Stocks: $8.8 million
Bonds: $13,975
Bills: $4,455
Gold: $14

Adjusted for inflation
Stocks: $599,605
Bonds: $952
Bills: $304
Gold: $1


Stocks beat the pants off all other investments over the same time. Its not even close!

Critics will say that average investor does not invest for 200 years. Fair enough.
But research has shown that even for shorter periods like 5 to 10 years, stocks still outpace the other investments on average even though there may be periods of under performance.

Additionally, people correctly point out that real estate was not included in the above comparison. Investment in real estate is easier than ever with REITs (Real Estate Investment Trusts), which can be bought and sold like stocks. Another advantage of real estate is the extended returns one can achieve with leverage.

Jack Clark Francis at Baruch College, New York City, and Roger G. Ibbotson at Yale University compared real estate with 15 different "paper" investments – stocks, bonds, commodities and real estate investment trusts (REITs) from 1978 to 2004. They reported the following returns:

• Housing – 8.6%.
• Commercial property – 9.5%.
• The S&P 500 (proxy for stocks) – 13.4%.

In spite of the strong housing market of the last 2 decades, stocks still came out ahead. Additionally, stocks have several advantages – better performance, low costs, diversification and amount of effort needed by the investor - compared to real estate. The recent downturn in the housing market has shown us how difficult it is for some homeowners to sell their house in a down market.

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Time to take charge

Wake up Call

One would think that in today's society, which encourages putting self before others, everybody would make their finances the top priority. The truth, however, is that we are not financially prepared. In my earlier post, I had listed some of the reasons why the individual investor is not financially savvy.

In this post, I would like to talk about the reasons why we need to take charge of our finances:

Retirement

• According to the Employee Benefits Research Institute (EBRI) 2007 Retirement Confidence Survey, nearly 50% people have less than $25,000 saved!
• Many companies are discontinuing defined benefit plans (pension plans) and moving to defined contribution (401k plans).
• Individuals are responsible for their retirement accounts. Individuals need to be aware of different fund types (equities, income and sector funds), asset allocation and expenses among other things.
• Social security system may not be solvent when we retire.

Health care

• Health care and medical insurance costs , which have been steadily increasing, are expected to be majority of the retirement spending.
  

Negative savings

• We spend more than we earn. According to latest savings survey, national saving rate is -1% ! You do the math - I do not need to add anything here except that we should not forget the "Live Below Your Means" mantra.
  

Education costs

• College costs are increasing faster than inflation rate. For some of the top schools in the country, annual tuition and boarding costs are ~$40,000. Do you have enough money saved for junior's Ivy League education?

Estate Planning

• If you are lucky to leave a legacy behind, you need to establish the right trusts and estates to provide for your family and take care of other goals like charitable donations. According to some estimates, probate and estate settlement costs (a.k.a death taxes) can be up to 10% of your estate.
  

Fun money

• This is how we pay for the fun stuff - vacations, second home, cars, big screen TV, etc. While we like to splurge on vacations and toys, it makes sense to plan for such purchases so our saving plan doesn't derail.