(May 23) – “Past performance is a rotten guide to future results. But that hasn’t deterred investors. Folks love to pore over stock-market data, hoping to divine the future. But unfortunately, while the past gives credence to certain investment principles, it doesn’t offer much help to those looking to beat the market,” writes Jonathan Clements in today’s Wall Street Journal.
“We have U.S. stock data going back two centuries. What can we learn? Three lessons stand out.”
“First, it pays to take risk. ‘The longer we go out, the more pronounced the risk-reward trade-off becomes,’ says Scott Lummer, chief investment officer of mPower, a San Francisco online investment adviser. ‘Bonds beat cash, stocks beat bonds, small stocks beat large stocks.'”
“Second, unlike bonds or Treasury bills, stocks have proven to be a wonderful long-run defense against rising consumer prices, outpacing inflation by an average seven percentage points a year.”
“‘We’ve had two centuries of remarkably constant average returns,’ says Roger Ibbotson, a finance professor at Yale School of Management. ‘But we’ve been the most successful country over the past two centuries, so it may be a high estimate of the performance going forward.'”
“Third, logic argues that stock-market diversification works, and history provides plenty of confirmation.”
“If you own a mix of large, small and foreign shares, you reduce your portfolio’s overall price gyrations, because these stocks won’t move in sync. Still, the concept of diversification came under fire in the late 1990s, as blue-chip U.S. shares outpaced other sectors for four consecutive years.”
“‘It would have been best to have an all-U.S. stock portfolio in recent years,’ says William Reichenstein, an investments professor at Baylor University. ‘But we didn’t know that before the fact. Looking forward, seeing as we don’t know what will be the big winner, it makes sense to split your eggs among U.S., European and Asian stocks.'”