Henry Ford said history was bunk. But, in his new book, “Risk & Reward: How to handle market volatility and build long-term wealth,” Ben Carlson relies on history to defend investing in U.S. stocks.
Carlson calls the U.S. stock market “the greatest wealth-building machine ever created,” and nudges his readers into thinking its success will continue.
Like many analysts and strategists who came of age after the financial crisis and latched onto indexing (surely a benefit compared to the alternative), Carlson delivers a blizzard of historical data showing how well U.S. stocks have done under different circumstances. And perhaps with a kind of wink and a nod (because who knows the future?), he implies that the future should resemble the past.
Whether they know it or not, the post-crisis upstarts like Carlson, who are now the establishment, are indebted deeply to Daniel Kahneman’s and Amos Tversky’s 1979 paper on “prospect theory,” which argues that human beings do not maximize “expected utility,” and experience loss more painfully than they experience gain as satisfying.
Mosquito Worry
The first chart in the book displays that debt. It’s not about investing. Instead, it shows that more than 800,000 people per year are killed by mosquitoes while less than 10 are killed by sharks, despite the more prevalent fear of the latter. In other words, human beings misjudge risk badly.
So, now that you’ve slathered on your mosquito repellent after taking that refreshing dip in the ocean, are you investing after a bad month or year? Or a good month or year? Or maybe at an all-time high? In any case, no problem.
In the past, any of these moments has been a good time to invest in stocks, especially if you have time to ride out volatility. Carlson has the charts to prove it, many of them breathlessly discussed in the first pages of the book. The implication is that history will repeat.
Any available data shows that stocks have done well and beaten inflation handily for a century. But for five- and 10-year periods — and even longer — things are less certain, as Carlson’s own blog post from 2014 that inspired the book shows. "What if You Only Invested at Market Peaks?" reveals things that create problems for his argument.
Hypothetical Bob
Carlson has a hypothetical investor in that blog post, Bob, invest at four market peaks — $6,000 in December 1972, $46,000 in August 1987, $68,000 in December 1999, and $64,000 in October 2007 — for a total investment of $184,000. Bob winds up with $1.1 million at the end of 2013 when he retires.
Turning $184,000 into $1.1 million sounds pretty good, but Carlson doesn’t list that the four peak-market investments produced annualized returns of 10.29%, 9.33%, 4% and 5.4%, respectively. Investment-grade bonds (Bloomberg US Aggregate) beat the third (1999) investment over the subsequent 14-year period leading up to Bob’s retirement. That’s a long time for bonds to outpace stocks. And a balanced portfolio (Vanguard Balanced Index [VBINX]) beat the third and fourth (2007) investments.
Also, the first, and by far smallest, investment of $6,000 in December 1972 resulted in $446,000 at the end of 2013. In other words, around 3.3% of the total money invested at the start of the period resulted in 41% of the total wealth produced at the end of the period.
And that illustrates a problem with the pro-stock argument. Most people aren’t investing a lot of money at the beginning of a 40-year period even if they are diligently salting away some of their paycheck every couple of weeks for that long. Most people’s savings don’t have four decades to compound. Carlson deserves kudos for setting up his hypothetical that way — with the smallest contribution coming first.
Time in the Market Matters
His hypothetical shows you can buy stocks with gusto before crashes if you have many decades ahead to recover. But that may not work if you have less time – even 14 years. The mighty U.S. stock market isn’t always that mighty.
Nevertheless, as Carlson states at the end, quoting Jack Bogle, “you have to invest” if you’re going to give yourself a chance to have something in retirement. “Risk exists in the markets. . . . but the alternative for stepping out into the unknown is the known of never building wealth in the first place.” Fair enough.
Invest, by all means, as Carlson, channeling Bogle, says. But know where your returns are coming from and what might threaten them.
Read more by John Coumarianos:
John Coumarianos is the founder and CEO of Mindful Advisory LLC.
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Henry Ford said history was bunk. But, in his new book, “Risk & Reward: How to handle market volatility and build long-term wealth,” Ben Carlson relies on history to defend investing in U.S. stocks.