Tuesday, June 18, 2013

The 90% Sure Thing

courtesy:  Barry Bannister, Stifel
Over the weekend I found myself watching a lecture on YouTube that Warren Buffett gave to a group of MBA students probably about a decade ago.

http://www.youtube.com/watch?v=iCvDlAlSnog

(Okay, so I don't have the most exciting weekends - blame it on middle age!).

One of the things that Buffett has consistently emphasized throughout his career is the fact that he focuses on the future prospects for a business, and ignores whatever the economy will do or not do.

In this clip he talks about his investment in Coca Cola.  He notes that you could have bought a share of Coke for $40 a share when it went public in 1919. In the intervening years all sorts of events happened - world wars, Depressions, etc. - but the underlying business of Coke continued to grow.

At the time of his talk, Buffett said that $40 investment would be worth $5 million.

In a way, this is no different than investing in the overall market.

The chart I have reprinted above shows the rolling 10 year returns for the U.S. stock market since 1825.

If you look carefully at the chart, you can see while the total returns varied considerably, investing in stocks and reinvesting the dividends was a money-winner.

And in the rare 10 year periods when stocks did not deliver positive results, the returns were only slightly negative.

Investing in companies, rather than focusing on broad economic trends, has been a 90% sure thing for almost 200 years, and there is no reason to believe the next 10 years will be any different.

Let's put this in practical terms.

Assume for the moment that you are 55 years old, and plan on retiring in 10 years. Considering your investment alternatives - stocks, bonds, cash - the best return potential is almost certainly found in the stock market.

Viewed in this manner, the question of how to allocate a portfolio with a 10 year time horizon becomes fairly straightforward.

This is not to say that bonds should not play a role to dampen volatility. There will doubtlessly be time ahead when stocks will move lower, and the news will seem grim.

However, if you are truly investing with a longer term view, it is hard to argue that stocks should not play a significant role.