Taking stock / The year history was rewritten
The business pages today will be dripping with gory red ink, describing the year that was. The numbers will be horrifying, the stories gloomy, the mortification vast.
The year 2008 taught the experts a lesson in humility. The lesson for the global banking system was especially painful: The people supposed to be the biggest experts of them all on investments and risk were responsible for the most egregious mistakes. Their blind greed blew up in their clients' and investors' faces.
If we learned anything from this crisis, it's yet again the importance of taking the long-term view.
At the end of 2003, we began warning our readers about economic policy under U.S. President George W. Bush and his Fed chief, Alan Greenspan. The United States had become dangerously leveraged, we wrote, and could blow up in all our faces.
Yet the markets roared on, Greenspan and his successor Ben Bernanke continued to pour in money and Washington continued to urge Americans to use their houses like bank ATMs. Detractors of this profligate policy were considered to be grudging dunderheads who couldn't grasp economics in the age of global financial markets and the rising Far East.
Then came 2008, which rewrote the history of the last five years.
In the case of Wall Street, down which strode the Masters of the Universe of the early 1980s, it rewrote the last 20 years.
Looking at 2008 in Israel's capital market, we'd best leave the hair-raising numbers aside and take the longer view; for instance, the one shown in the graph.
If you think that taking the long-term view is merely our way of finding some optimistic twist after a horrible year, read on. You may be surprised.
Yep. The index was called "free" because after the bank stocks collapsed in 1983 and the state nationalized them all, the state also guaranteed a minimum return on bank shares. It essentially turned the stocks into dollar-denominated bonds. So, to keep track of the real stock market, the one not secured by government, the exchange developed its index of "free" stocks, which meant not including the bank shares.
Why are we dwelling on this? Just to note that dire crises with the banking system at their center are nothing new. Nor are massive manipulations right under the regulator's nose.
First lesson: Towering crises are an integral part of the financial world, and when they happen, they can rewrite history going back years.
If you got in at the start of 2007, by yesterday you had lost 21.6%. If you got in at the start of 2005, you were down 12.5%. Start of 2004? You've broken even.
TheMarker's calculates that in the last decade, you've lost money almost whenever you got in, except for the start of 2003.
Stocks then had sunk very low, and if you got in then, you're up 9.1% a year on average, which is a lot.
Second lesson: Investing in stocks for less than 10 years is very risky.
Third lesson: Over decades, stocks can generate inflation-adjusted returns of 5% to 7%, and thanks to compound interest, 7% a year over decades is a great amount. Over 20 years for instance it's 287%.
Corollary lesson: Don't succumb to irrational exuberance and buy at the peak. It's hard to recognize peaks, though, so one answer is to buy in increments over time.
As for you stock-pickers out there who think you can beat the indexes, we beg to note that analyses show that few professional investment managers can actually do that trick. Worse, even if there are investment managers out there who can beat the index, you can't know in advance who they are, only in retrospect.
And you can't know how they'll do in the future. Bill Miller of Legg Mason had become legendary, beating the market for 20 years. In the last three years he lost most of his clients' money with bad picks.
Now take your inflation-adjusted returns, deduct fees and you're left with anywhere from 2% to 5.8% a year. Say 4% on average.
Fourth lesson: You think management fees of 1% or 2% a year are nothing because of the fluctuations of the market. You're wrong. Over long periods this level of fee can eat up 30% to 80% of your profits. If you're in for the long run, choose investment vehicles that charge the lowest fees. For example, "executive insurance" schemes swallowed half their depositors' profit in five years.
Sorry, not quite. You have to factor in the cost of money, which means, what you would have made on risk-free government bonds. We find that over time, the Israeli stock market outperformed these by only 1% or 2%. Given the volatility of stocks, one wonders if that difference compensates for the risk and sleepless nights.
Fifth lesson: Stocks do outperform government bonds over time, but not by as much as you'd thought. And it's all about the timing. But what's for sure is that the stock market is a death trap for short-term investors. You have to get in for 10 years at least, and 20 or 30 is better, and avoid high management fees. It's just a shame that the cost of these lessons is so dear.