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Allan Sloan

Stocks' Payoff Myth

By Allan Sloan
Sunday, January 16, 2005; Page F01

Friday was a historic day -- and I'll bet you didn't even notice. No, I'm not talking about it having been the 91st anniversary of Henry Ford's introduction of the assembly line for the Model T. Or the 221st anniversary of Congress's ratification of the Treaty of Paris, which ended the Revolutionary War. I'm talking about something more recent and mundane: the fifth anniversary of the Dow Jones industrial average's all-time high, set on Jan. 14, 2000.

Back in the day, the stock market bubble was still with us, and the Dow closed at 11,722.98. Twelve thousand, and points north, seemed within easy reach. Alas, the Dow promptly headed south, and has never come close to what it was.

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At Friday's close, the Dow was still 10 percent below its all-time high. And that understates the damage investors have suffered since stocks peaked five years ago.

The Standard & Poor's 500-stock index and the Wilshire 5000, both far better measures of the market than the 30-stock Dow, are down 22 and 19 percent from their highs of March 2000. And the Nasdaq market? Yeckummm. It's down 59 percent from its peak, which means it has to way more than double just to get back to where it was five years ago.

I'm dragging out all these numbers because there's a lesson here, one that some people have forgotten because stocks have done well the past two years. It's this: Even though stocks have produced double-digit profits on average every year, the market can go down and stay down for extended periods. So on average, you do great. But in the real world, you can lose your shirt if you need to cash in your chips during a bad market patch and don't have the staying power to hold on for better days.

This all matters, big time, given the trial balloons the Bushies are launching to substitute private investment accounts for about half of Social Security's current benefit formula. (My math: The change they're floating to tie benefits to inflation rather than wages would cut benefits for next-generation workers by 46 percent, compared with the current formula.) On the charts, your private investment account looks great: Stocks have produced an average of 10.4 percent a year for investors since 1926, according to Ibbotson Associates. That makes stocks sound like sure-fire investments. But there's no guarantee that you'll actually make that kind of money, unless you have staying power measured in decades. If you got in at the Dow's 1929 peak, you had to wait until 1954 to break even. In 1964, you had to await 1972.

Now, it's 2000 to who-knows-when. You make good money on average, but life isn't always average. A six-foot man can drown in a lake that averages six inches deep if he steps in the wrong place.

I'm not any sort of guru, but simple arithmetic makes it unlikely that stocks over the next decade or two will repeat what they've averaged for the 79 years covered by Ibbotson.

Here's why. A large part of stocks' long-term returns to investors has come from cash dividends, which are far lower now, relative to stock prices, than they were.

Some 4.25 percentage points of stocks' 10.43 percent total return came from cash dividends, according to Ibbotson, and 5.93 percentage points came from share-price increases. (The rest came from reinvesting the cash dividends in additional shares.) Today, the S&P 500 dividend yield is well under 2 percent. Allow 6 percent a year for share-price increases -- that's generous, given the current high level of stock prices -- and you end up with a return of around 8 percent. That's more than two percentage points below the long-term historical return -- and about two points below the assumptions underlying the administration's Social Security private-account projections.

It's one thing to come in with a less-than-projected return on your 401(k) account or your regular stock portfolio. That's not basic-needs money -- or at least it shouldn't be. But if you're counting on stocks to supplement your sharply reduced Social Security benefit to pay for basic needs, you're toast if stocks come in low.

Ditto for bonds, which have excellent long-term returns -- almost 6 percent in interest income and price appreciation since the end of 1925 -- but whose returns for the next few decades are likely to be lower, for technical reasons having to do with current interest-rate levels.

One last piece of historical trivia. In addition to signaling the peak of the Dow, Friday also marked the 51st anniversary of the short-lived marriage of Marilyn Monroe and Joe DiMaggio. Like the bull market, it was fun to watch while it lasted. But as history teaches us, nothing goes on forever.

Newsweek librarian Rena Kirsch contributed to this column.

Allan Sloan is Newsweek's Wall Street editor. His e-mail address is sloan@panix.com.


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