Breaking the Chains of Time

In addition to the full sample period (1945-2022), the authors also analyzed three 26-year subsample periods, which by pure chance corresponded to three distinct periods. The first subperiod, 1945-1970, corresponded to the establishment of a new world order, the creation of the Bretton Woods system, and the emergence of mutual funds. The second subperiod, 1971-1996, corresponded to a tidal wave of deregulation, the beginning of the end of a certain form of financial orthodoxy, and the emergence of passive investing. The third subperiod, 1997-2022, corresponded to what Alan Greenspan, former chair of the Federal Reserve of the United States, called a period of “irrational exuberance,” the advent of modern monetary theory, and the boom of derivative instruments. They also considered separately the last 10 years of the sample to show how exceptional the recent past has been to try to mitigate the so-called representative bias.

Given recent concerns over inflation, the authors then split the sample into four regimes defined by the evolution of both growth and inflation (up or down). The size of these subsamples was heterogeneous. The case where growth and inflation were down (up) accounted for 2% (62%) of the observations, and the case where growth was down (up) and inflation up (down) accounted for 26% (10%) of the observations.

To have a more holistic view of our socioeconomic system, they also ran a basic machine learning algorithm on a selection of 10 macroeconomic indicators (the levels of the Fed funds effective rate, inflation, the unemployment rate and of wealth disparity as well as the percentage changes of the monetary base, the GDP, the oil price, the two-year/10-year yield spread, the USD/British pound exchange rate, and productivity). By so doing, they obtained four slightly more balanced regimes. The first and third regimes were, roughly speaking, normal periods of economic contractions and expansions. They tended to alternate and accounted for respectively 31% and 43% of the observations. The second regime, which dominated in the 1970s and 1980s, accounted for 25% of the observations. And finally, the fourth regime or “black swan” mode, which we experienced during the great financial crisis in 2008 and the coronavirus pandemic in 2020, accounted for 1% of the observations.

The authors analyzed the evolution of a series of metrics as the investor’s investment horizon stretched into the future (i.e., from one to 40 years). To gain an understanding of the dispersion of potential outcomes, they measured the magnitude of the relative performance of a passive exposure to a highly diversified basket of stocks over the full sample and conditional upon the relative performance being positive or negative.

Research and findings

Roccaro and Vaissié found that U.S. stocks lived up to, on average, investors’ expectations of outperforming one-month Treasury bills over the long term, but not always. They found that, because the performance of the equity market is time-varying and regime-dependent, long-term investing should be significantly longer than what many investors consider long-term.

U.S. stocks not only generated strong raw/real returns, +11.68%/+8.06% per annum, over the whole sample, but they also outperformed the other assets by a significant margin over most of the periods evaluated. Those results mask significant variations both through time and across regimes. The researchers also observed a general downward trend through time (with the Bretton Woods era appearing as a golden age for equity investing) and more generally for the transfer of value through time (with an average real return of 9.22% per annum and an average outperformance relative to gold of 11.87% per annum). The so-called modern monetary theory era turned out to be more challenging though still supportive so far (with an average real return of 7.18% but an average outperformance relative to gold of only 2.68%). In this respect, the performance of the last 10 years appears to be an outlier (with an average real return of 10.21% per annum and an average outperformance relative to gold of 11.53% per annum).

It is essential to acknowledge the volatility associated with stocks. While they offer the potential for significant returns, they also come with higher risk. This is especially important for investors with lower risk tolerance and those closer to their retirement age. Diversification across asset classes can be a useful strategy for balancing risk and return. Though U.S. stocks outperformed, they were volatile (annual volatility oscillated around 15%). U.S. stock volatility also showed a general upward trend through time (annual volatility increased from 12.97% to 16.22% between the first and third subperiods) – equity investing is not a long, calm river.

Investor takeaways

The primary takeaway for investors should be to embrace a genuine long-term perspective, extending their time horizons to at least 20 to 30 years. The traditional notion of long-term investing (five to 10 years) may fall short of realizing the full benefits of long-term strategies.

My firm’s analysis shows that since 1927 there have been significant periods of U.S. stock returns falling short of T-bill and long-term bond returns, as shown in the table below. Although these incidents are rare in the historical data, there have been durations of up to 17 years of underperformance for the S&P 500 Index versus T-bills (1966-82) and durations of up to 40 years of underperformance of U.S. large-growth stocks versus long-term government bonds. These durations are not trivial and would have a significant impact on the relative wealth of U.S. stock investors with the misfortune of their investment horizon limited to one of these periods.

There is hope. Generally, if an investor wants to reap the benefits of stock investing, their investment horizon should span at least three (two) typical market (business) cycles. More specifically, it generally takes five years for the downside risk of an equity investment to be mitigated; a minimum of 10 years to have a quasi-guarantee to have a positive raw return; no less than 20 years to be fairly certain to achieve a positive real return, do better than the risk-free rate, or than an investment in real estate; as much as 25 years to be quite sure to outperform a prudent investor; and 30 years to do better than gold. It can be even longer depending on the biases embedded in the investor’s equity portfolio, and above all on their propensity to resort to risk-control mechanisms to dampen the impact of market gyrations on their portfolio.

A genuine long-term perspective extends beyond the commonly assumed five to 10 years, setting the bar at a minimum of 20 to 30 years – challenging the conventional notion of long-term investing and prompting investors to extend their time horizons.

The research underscores the importance of a truly long-term perspective as a key strategy for success in long-term wealth accumulation. But investors should exercise caution, remain flexible in their approaches, and consider the potential uncertainties of future investment decisions, as we are stuck with the returns given over our unique lifetime. While long-term investing can be a powerful tool for building wealth, it requires careful planning, a clear understanding of the risks involved, and the discipline required to stay the course during the long periods of underperformance.

Larry Swedroe is head of financial and economic research for Buckingham Wealth Partners, collectively Buckingham Strategic Wealth, LLC and Buckingham Strategic Partners, LLC.

For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is based on third party data and may become outdated or otherwise superseded without notice. Third party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio nor do indices represent results of actual trading. Information from sources deemed reliable, but its accuracy cannot be guaranteed. Performance is historical and does not guarantee future results. All investments involve risk, including loss of principal. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency have approved, determined the accuracy, or confirmed the adequacy of this article. LSR-23-580

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