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Does Long Term Investment Work?

Much investment advice tells you to put your money into a basket of US stocks and hold on. The argument for investing in stocks is that over the years, the US stock market has routinely created wealth for those who stay invested. However, how does that work out when you look at the profits of long term investments and inflation? After all, the reason we save and invest is to maintain our purchasing power in retirement and to increase it generally over time. The question is, does long term investment work?

Does Long Term Investment Work?

First, let’s review the experience of the US stock market since 1929. The argument is that even if you never sold any of your stocks during the 1929 crash that you would have been ahead again after a few years. This “analysis” is done by following the Dow Jones Industrial Average over the years. It is true that the Dow uses an adjustment to allow for stock splits and dividends. But, the first ETF was only born in 1993 and they were not common until more than a decade later. Today you can put money in the SPDR Dow Jones Industrial Average and forget about it. But, that option was not available for decades after 1929. You would have needed to buy every stock in the DJIA at that time. And that approach would not have worked out very well!

Investing in Stocks in the 1929 Dow Jones Industrial Average

Because the recovery of the Dow Industrial Average is used as an argument for staying with the stock market through thick and thin, we looked at the stocks in the 1929 DJIA. As today, there were thirty stocks. Of those thirty, twelve survive today as the same company in the same business or, as in the case of Union Carbide Corporation, a part of a company in the same business, Dow Chemical. Here are the twelve.

Survivors from the 1929 DJIA

  1. Atlantic Refining Company merged and became ARCO
  2. Curtis-Wright Corporation continues under the same name
  3. General Electric Company continues under the same name
  4. General Foods Corporation is part of Kraft Foods
  5. General Motors survived bankruptcy and continues in the same business
  6. International Harvester Company downsized and continues as Navistar
  7. National Cash Register Company continues as NCR
  8. Sears Roebuck & Company is a shadow of its former self as Sears
  9. Standard Oil of New Jersey is now ExxonMobil
  10. Union Carbide is part of Dow Chemical
  11. United States Steel Corporation remains as a shadow of its former self
  12. Westinghouse Corporation continues its nuclear power business as Westinghouse Electric Company

Of the dozen that still resemble their former selves, US Steel and Sears have gone from being the first in the world in their businesses to being 26th place in the case of US Steel and ready to fall off the earth in the case of Sears. While General Electric still is a huge business with an impressive cash flow, their profits have been awful for nearly a decade and their stock price has suffered.

Non-survivors from the 1929 DJIA

The eighteen other companies were taken over by other companies, changed their business models so as to be unrecognizable as their former selves, went out of business, or were broken up by the SEC.

The point of all this is that in order to have benefitted from the recovery and forward growth of the DJIA, you would have had to buy and sell stocks so as keep matching the constituents of the Dow. A problem with that approach is that companies get kicked out of the DJIA after their performance gets bad and not beforehand. Thus, a better approach would have been to have learned how to calculate and use intrinsic stock value to guide your choices. But, then you would not have been tracking the DJIA!

Long Term Inflation

According to the CPI Inflation Calculator, to have the same purchasing power as $100 in 1929 you would need $1,499.38 today. In other words, your investments would need to have increased fifteen-fold after taxes to simply hold their purchasing power today. This would never have worked out with the majority of the stocks in the 1929 DJIA list.

Are Stocks for the Long Term a Problem?

Market Watch published an opinion piece questioning investment in stocks for the long term. They claim that there is a 30% chance of losing money by holding stocks for five years, a 20% chance of losing money over 20 years, and a 12% chance of losing money over 30 years. They looked at markets across the world and went back to the middle of the 19th century. Many unforeseen events like world wars played havoc with investments but they note that we are now going through the third “once in a lifetime” crisis in the last 20 years!

Does Long Term Investment Work?
Ideal Case for Long Term Investment

So, Why Are Some Investors So Successful?

But, if stocks are such a terrible idea, why is Warren Buffett so rich that he can give away about $7 billion a year and remain one of the three of four richest people on earth?

The key may be in Buffett’s comment that stock portfolio diversification is merely protection against ignorance. If you follow his recipe of only investing in companies whose business plan he understands and whose business plan is likely to keep making money over the long term, you could avoid quite a few of the losses in the 1929 DJIA group. Jim Cramer was quoted as saying that the average investor should keep his investments down to five or less as it is too much work to track more unless you invest full time.

It would seem that if you want to engage in short term or long term investing, you need to pay attention or you need to accept lower gains. Buffett, again, has said that a good approach for someone who does not have the time or interest to track stocks should buy shares of an ETF that tracks the S&P 500 (which tracks 500 stocks and not 30).

Picking Stocks to Invest in Long Term

To do this successfully, you need to understand and use fundamental analysis. And, you need to continue to use the same analysis to decide whether or not to stay invested in any given stock. Past performance and current cash flow are good guides to investing in stocks, but you still need to understand just why the company is making money and how that is going to continue into the distant future! Using the Dow Jones Industrial Average as a starting point by investing in an ETF that tracks this average can be a good starting point for long term investing.

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