Markets & Personal Finance

To Get Ahead, Stick Your Neck Out


Nobody’s forcing you to take risks as an investor. You’re free to stash your savings in three-month Treasury bills at a current yield of 0.02 percent a year. Just bear in mind that if that rate persisted, it would take you 3,500 years to double your money. Actually, it’s worse: If inflation averaged 1 percent annually, the buying power of your ultrasafe T-bills would be reduced over that period to one-quadrillionth of its current value.

Hunkering down may be a prudent short-term strategy, but eventually you need to poke your head out of the foxhole and look for ways to make some real money. The good news is that stocks, high-yield bonds, and real estate are cheap by historical standards and stand a good chance of appreciating strongly over the next decade or so. In fact, after five monthly declines in a row, stocks jumped 9 percent from Oct. 1-Oct. 25.

“Stock values today are the most attractive relative to bonds in more than one-half century,” Jeremy Siegel, a professor of finance at the University of Pennsylvania’s Wharton School and author of Stocks for the Long Run, wrote in an Oct. 24 e-mail. “It is the fear of short-term fluctuations that keeps stock prices so low, and this generates the superior returns that stockholders have always achieved when buying at favorable valuations, such as we see today.”

You can think of today’s ultralow interest rates as a hard shove from Federal Reserve Chairman Ben Bernanke to get you out of your defensive posture. One way low rates juice economic growth is by inducing investors to reach for yield by putting their money to work in riskier investments. That juicing went too far in the 2000s, inflating an asset bubble. But at this stage of the feeble recovery, the Fed is judging that more risk-taking would be a good thing.

Persuading people to buy when prices have gone down is a challenge. In focusing on the weak returns in stocks over the past decade, “investors are all looking in the rearview mirror,” says Daniel J. Genter, chief executive officer and chief investment officer of RNC Genter Capital Management in Los Angeles. Skittish investors withdrew an estimated net $341 billion from U.S. equity mutual funds from the start of 2008 through September 2011, including $61 billion so far this year, according to the Investment Company Institute. In its annual survey, the institute found that the share of mutual-fund-owning households that want below-average or no risk rose to 23 percent in May of this year, from 14 percent in May 2008, while the share seeking above-average risk shrank.

It’s the same in housing as in stocks. The unprecedented decline in home prices seems to have persuaded many Americans that things are bound to keep getting worse. According to a Sept. 15-16 poll by Rasmussen Reports, only 13 percent of Americans expected the price of their home to rise over the next year, and just 36 percent thought it would go up over the next five years. In contrast, back in December 2006, when prices were overvalued, a Pew Research Center survey found that 81 percent of respondents expected their home price to increase.

As with stocks, the drop in home prices makes it a good time to buy, says David Kelly, chief market strategist for J.P. Morgan Funds. “Home prices look downright cheap not only from the perspective of mortgage rates and income, but also relative to the cost of renting or the cost of constructing a new home,” Kelly and analyst David M. Lebovitz write in a report called “Housing: A Time to Buy.” Meanwhile, lending standards remain so stringent that you aren’t likely to get in over your head. Kelly says, “If you can convince a bank that you’re good for a mortgage, you’re definitely good for a mortgage.”

Might home prices—or stocks—fall in coming months? Certainly. But history shows that the longer your holding period, the less likely you’ll lose money by taking more risk. The MSCI World Index—a broad measure of global stock performance—typically goes down in 4 of every 10 months. But the probability of a decline shrinks to 25 percent over a full year, 7 percent over 10 years, and “almost never” over 20 years, according to Barclays Wealth (BCS). Sustained nationwide home-price declines like the current one are even rarer than stock market crashes. And even after what’s by far the worst housing bust since the Great Depression, the Case-Shiller 20-City Home Price Index is still above its level of early 2003.

All this is not to advise risking everything on a horse that goes off at 50-1. “You have to be bound by what the market is offering,” says John C. Bogle, founder of mutual fund company Vanguard Group. “When you try to get more there than is available, you start to go out on the tree limb. And at some point you go so far out the tree snaps.”

Investors in 401(k)s have the right attitude. They put their investing on autopilot. During the market’s swings of 2007 through 2010, Vanguard Group found that the share of contributions going into equities in its defined-contribution plans stayed within a narrow range of 68 percent to 74 percent.

The trick is to adopt the same unruffled approach for investments outside the 401(k). That includes buying a house. Unlike the slow drip of a 401(k), a home purchase is an all-or-nothing decision that’s not easy to approach dispassionately. But focusing on the facts can help. So relax, investors. Even if you don’t catch the very bottom, over the long term you’re likely to do better than 0.02 percent a year.

The bottom line: While 23 percent of mutual fund investors want below-average risk, playing it safe today almost guarantees that you’ll fall behind.

With Nikolaj Gammeltoft and Karen Weise
Coy_190
Coy is Bloomberg Businessweek's economics editor. His Twitter handle is @petercoy.

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