Friday, January 21, 2005

Capitalism and Long-Term Investing

Suppose you were given a chunk of money, say, a million dollars, to work with a round figure. How would you invest it in today's world? Stocks or bonds or real estate? Bank CDs or cash? How about gold and oil? U.S. or international markets--Europe, Japan, China, Korea, Australia? There certainly is no shortage of choices.

Let's begin with a thumbnail sketch of the global politico-economic landscape. Following World War II, we lived in a bipolar world, with capitalism (U.S., Europe, Japan, Australia) pitted against communism (U.S.S.R., East Germany, North Korea, China). The U.S. and U.S.S.R. engaged in a Cold War arms race, expending a sizeable amount of GDP to build and stockpile nuclear weapons and support their large militaries. Well, this Cold War antipathy and paranoia was obviously very wasteful and, ultimately, the less efficient economies crumbled: China began to open her doors in 1978, and today shows promise of becoming the world's next economic leader by the end of the 21st century. The Berlin Wall fell in 1989, dramatically reunifying East and West Germany and helping to set the stage for economic cooperation in Europe and, among other things, the creation of the Euro in 1999. In 1991, the U.S.S.R.'s economy fatally imploded from internal weakness. Today, here we are in 2005, with North Korea struggling to maintain her economy, while (South) Korea flourishes by comparison.

The outcome over the past half century is crystal clear: Capitalism has outrun communism as an economic system. The trend for the next half century is also clear: We will likely see continued growth of the world's capitalistic economy, an environment in which private enterprise, for-profit corporations and entrepreneurs bring home all the kudos.

As investors, we are participants in this capitalistic system. For guidance on what to invest in, we simply need to ask: Who wins in capitalism? The nature of capitalism is that risk-takers profit, meaning that, on the whole, equities tends to outperform bonds. The world's multi-billionaires--Gates, Buffett, the Waltons, Ellison and others--are living examples of higher returns from equities. The historical long-run behavior of the financial markets, both in the U.S. and internatially, is well-documented in Triumph of the Optimists (2002), by Dimson, et al. The message is that over the past hundred years in all countries with available data (U.S., Canada, U.K., Ireland, France, Germany, Switzerland, Italy, Spain, Denmark, Belgium, Netherlands, Sweden, Japan, Australia, South Africa), equities have outperformed bonds. Representative examples of long-run (1900 to 2001) inflation-adjusted annualized returns are:

Country: Equities vs. Bonds

Australia: 7.5% vs. 1.1%
U.S.: 6.5% vs. 1.6%
U.K.: 5.6% vs. 1.3%
Japan: 4.3% vs. -1.5%
France: 3.6% vs. -1.0%
Germany: 3.3% vs. -2.2%
Italy: 2.3% vs. -2.1%

For verification and my own edification, I have also downloaded total return data on the U.S. market from and observed that, since as far back as the data go (late 1800s), there has never been a 30-year window when stocks (S&P 500) have failed to outperform both bonds (10-year Treasury) and cash (T-bills). This long-run outperformance of equities held true even for an equity investment beginning in 1929, just prior to the stock market crash and Great Depression of the 1930s. Looking ahead, I suspect that even for unfortunately timed equity investments begun in Japan at the end of 1989 before the collapse of the Japanese stock and real estate bubble, or in the U.S. in 2000 just before the bursting of the U.S. technology and Internet stock bubble, the familiar pattern will again hold true: Well ahead of their respective 30-year horizons--2020 in Japan and 2030 in the U.S.--the Nikkei 225 and Nasdaq stock averages will rise from ashes and equities will once again trounce bonds and cash.

Capitalism is a well-stocked train running along a well-built track, subject to delays (e.g., periods like 2000 to 2002 with lots of pain and suffering in the stock market) but unlikely to derail during the lifespan of anyone reading this blog. Aside from those wishing to make a habit of testing their powers of clairvoyance and trying to time the markets, anyone level-headed, informed, intelligent investor seeking high long-run returns should dedicate all or most of their available investment capital to equities. In our capitalistic world, the preponderance of evidence indicates that equities (both stocks and real estate) will continue to outperform other asset classes in the long run. Simply put, equity investing is the name of the game!


Blogger Anil Passi said...

So rightly said. The two best possible investments are in Property and Equity.

I would say Property is buy it and forget it type investment, as that grows regardless of any intervention. However with equities, one has to keep an eye. At the moment, one can make good profits by investing in Energy & Construction stocks. I am strategically planning to invest in funds, so that i do not have the hassle of keeping an eye.
Funds tracking Russian Oil can be a good investment too.

Good luck to all investors,
Anil Passi

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