Returns in the Long Term

How can you be expected to plan your retirement savings strategy when stock and bond returns have been as volatile and unpredictable as they have been in recent years? One answer is “by using a long-term perspective.” This article’s intention is to provide some food for thought in discussing the returns experienced by various asset classes over the 50-year period beginning Jan. 1, 1953 and ending Dec. 31, 2002.

An index measures the price performance of a class of securities. For instance, the Standard & Poor’s 500 Composite Index (the “S&P 500”) is widely viewed as a benchmark for the stock market. The S&P 500 is a broad-based, unmanaged index of 500 widely held domestic, mostly large-cap, stocks. Other indices concentrate on alternate niches (usually defined by capitalization) within the equity universe. Bond indices are often segregated by time to maturity. By looking at an index’s performance, we can view past price fluctuations and determine whether the asset class in question poses too much risk for the possible reward.

A worthwhile tactic is to look not only at an index’s year-by-year performance, but also the index’s performance in rolling periods of various length. For instance, you might have 20 years until you expect to retire. You, therefore, might want to study how a certain index has performed in 20-year rolling periods. Rolling periods are defined by length in years and follow consecutively. For example, 1952-1971 is a 20-year rolling period, as are 1953-72, 1954-73, 1955-74 and so on. Rolling periods can be adjusted to encompass shorter or longer periods. Since time tends to smooth out volatile fluctuations in performance, rolling periods can be seen as providing a more accurate long-term gauge than individual annual returns.

We must remember, however, that past results are no guarantee of future results. Furthermore, the results experienced by the indices used in this article are not to be construed as indicative of results that might be experienced by any investment portfolio.

Now, let’s look at some examples.

S&P 500
No period in the last 50 years has been as turbulent for stocks as the eight years beginning Jan. 1, 1995. Using the S&P 500 to represent equities, stocks enjoyed five consecutive years of increases, ranging from a low of 21 percent (1999) to a high of 37 percent (1995). For that five-year period, the S&P 500 increased 250 percent. Investors were euphoric about the potential for enjoying early retirement on the assumption that stock prices would continue to rise. This didn’t happen, of course. Three years of price declines followed, including a 22 percent loss in 2002. For the five-year period 1998-2002, the S&P 500 declined 2.9 percent. Stock prices have so far rebounded in 2003, but what is an investor to make of all this? Can you have any confidence in the ability of stocks to appreciate in price as you near the time when you will need to draw upon your accumulated savings for day-to-day expenses?

This is where a long-term perspective becomes necessary. How long “long-term” should be depends largely on how many years remain until an individual’s retirement. But consider that over the past 50 years, there have been only three five-year periods in which the S&P 500 has produced a negative return. Besides the 1998-2002 period cited above, the others were 1970-74 (-11.5 percent) and 1973-77 (-1.8 percent). The other five-year periods in that 50-year span were all positive, ranging from a low of 10.2 percent (1969-73) to the 250 percent gain (1995-99) mentioned earlier.

Now, let’s go out even farther on the time continuum. There has been no 10-year period in the previous 50 years that has resulted in a downtick in the S&P 500. The “worst” 10-year return was a 12.3 percent gain for the 1965-74 period. Even the 2000-02 debacle couldn’t erase the gains from the seven preceding years. The 10-year period ending Dec. 31, 2002 saw a 143.4 percent rise in the S&P 500. Furthermore, in the last 20 years, there have been only two 10-year periods with gains of under 200 percent (1974-83 and 1993-2002). Even neglecting the boom years of the late 1990s, there were several 10-year stretches in which the S&P rose more than 300 percent.

Likewise, there have been no 20-, 30- or 50-year periods in which the S&P 500 has resulted in a loss.

A look at the S&P 500 shows stocks to be volatile. In the last 50 years, the annual gain or decline in this index has been in double digits on 35 occasions (or 70 percent of the time). Yet, the index has consistently trended upward. Until the 2000 decline, the S&P 500 rose in every year but one from 1982 through 1999. Only 1973-74 marked a decline in consecutive years.

Aggregate and annualized performance results for this index for various periods beginning January 1, 1953 and ending December 31, 2002.

Nasdaq
The stock universe is much larger than just the 500 stocks encompassed by the S&P 500. Let’s take a look at the Nasdaq Composite Index, which is comprised largely of mid- and small-cap issues. Our research for this index goes back only as far as 1971, but is instructive.

Over the previous 31 years, the Nasdaq had 21 “up” years and 10 “down” years. The latter includes 2000, 2001 and 2002. Looking at five-year periods, only three times has the Nasdaq remained “underwater.” That would be 1972-76 (-14.2 percent), 1973-77 (-21.4 percent) and 1998-2002 (-14.9 percent). If you look at 10-year periods, the Nasdaq has been positive throughout, ranging from a low of 71.6 percent (1972-81) to a high of 794.7 percent (1990-99). Furthermore, no 20-year period shows the Nasdaq with a loss. Patience and a tolerance for high risk as well as roller-coaster fluctuations are requirements for an investor in these types of stocks. In the preceding 31 years, there have been only five years in which the annual percentage increase or decrease was in single digits. These stocks are volatile.

Aggregate and annualized performance results for this index for various periods beginning January 1, 1972 and ending December 31, 2002.

S&P MidCap 400
In 16 years, there have been 11 positive years (best, 50.2 percent in 1991) and five negative years (worst, -14.5 percent in 2002). In no five-year period has this index declined, ranging from a low gain of 36.1 percent (1998-2002) to a high gain of 181.5 percent (1995-99). Likewise, 10-year periods (all positive) range from 208.2 percent (1993-2002) to 509.3 percent (1991-2000). Annual percentage increases or decreases have registered in double digits in 12 of the 16 years.

Aggregate and annualized performance results for this index for various periods beginning January 1, 1987 and ending December 31, 2002.

Lehman Bros. Government/Credit
This index, which has a history beginning in 1974, is comprised of both government and corporate issuers of varying maturities. Only twice in the past 29 years has this index suffered a down year. Even then, the losses were slight: -3.5 percent in 1994 and -2.1 percent in 1999. In 12 of those years, the index enjoyed double-digit gains, topped by a 31 percent move in 1982.

At no time since 1974 has this index declined over any five-, 10- or 20-year period. All 10-year returns for this index exceeded 100 percent and all 20-year returns exceeded 500 percent.

Aggregate and annualized performance results for this index for various periods beginning January 1, 1974 and ending December 31, 2002.

Treasury bills
T-bills are fixed-income instruments of very short maturity issued by the federal government. Because T-bills are issued with the full faith and credit of the U.S. government, there has never been a year in which an investment in them would have yielded a negative result. Unlike other issuers, the federal government can print money to cover any projected shortfalls. This full faith and credit applies only to the timely payment of principal and interest, and does not eliminate market risk. Certainly less volatile than any other asset class, T-bill returns are historically in the low- to middle-single digits, although there are plenty of people who remember the early 1980s, when returns rose into double digits (as high as 15 percent for 1981). Of course, skyrocketing inflation had a lot to do with those high yields.

What kind of return can a T-bill investor hope for over several decades? That’s a little hard to tell because even long-term returns have been skewed by the early 1980s. For the most part, 10- and 20-year rolling periods beginning with those that ended in 1991 have had a percentage return lower than the period that preceded it. This trend may continue for as long as interest rates remain low. Having said that, five-year returns crested at 72.9 percent in 1983 and have been lodged in the 20 percent range for the last nine years. Ten-year returns peaked at 147.8 percent in 1987 and registered at 54 percent for the period ending Dec. 31, 2002. Hold T-bills for 20 years and your money would have grown 205.4 percent for the period ending Dec. 31, 2002, although that’s a far cry from 363.5 percent for the period ending Dec. 31, 1991. If you have 30 years in which to wait, you might enjoy growth of over 600 percent (609.8 percent through Dec. 31, 2002), although this figure might dip below 600 percent for the 30 years at the end of 2003. If so, this would be the first sub-600 percent return for a 30-year rolling period since that which ended in 1989.

Aggregate and annualized performance results for this index for various periods beginning January 1, 1953 and ending December 31, 2002.

Inflation
Many of the long-term returns we’ve cited look impressive at first glance. But put those returns into context. Put a 200 percent gain for 20 years against inflation for the same period. If inflation (represented by the Consumer Price Index) also measures 200 percent, you really haven’t gained anything at all. The money you invested 20 years ago would have the same purchasing power today as it did then, although the dollar amount is greater.

Aggregate and annualized increases in the Consumer Price Index for various periods beginning January 1, 1953 and ending December 31, 2002.

Remember those double-digit T-bill returns from the early 1980s we spoke of? They were largely a reaction to double-digit inflation in preceding years, such as 13.2 percent in 1979 and 12.5 percent in 1980. After inflation ate into the gains, investors were really left with single-digit increases in value.

In the long term, inflation has resembled a bell curve. That is, relatively low for 10- and 20-year rolling periods ending in the 1960s, consistently higher throughout the 1970s until peaking in the 1980s, followed by consistent declines through the 1990s into the present day. Inflation is one of many factors affecting real returns and bond yields, but is susceptible of historic analysis and worthy of mention in this article.

How might you use this information going forward? If, like many investors, you value the benefits of a diversified portfolio, you might compare these indices’ performances with your own risk-reward profile to make any adjustments to your portfolio that you believe are necessary. A diversified portfolio neither assures a profit nor guarantees against a loss, but it can help modify risk by spreading funds among asset classes.

The Standard & Poor’s 500 Composite Index is an unmanaged index of 500 common stocks reflecting large-capitalization stock performance, and is generally representative of the U.S. stock market. The Standard & Poor’s MidCap 400 Index measures the performance of the midsize company segment with an average market capitalization of $1.69 billion. The figures include reinvestment of all dividends.

“Standard & Poor’s,” “Standard & Poor’s MidCap 400 Index” and “S&P 500” are trademarks of The McGraw-Hill Companies, Inc.

The Nasdaq Composite Index measures all Nasdaq domestic and international-based common stocks listed on The Nasdaq Stock Market. Nasdaq data represent changes in price index value only.

Lehman Brothers’ fixed income indices are used by more than 90 percent of U.S. investors. Lehman Brothers makes no representations or warranties as to the accuracy, reliability or completeness of any information. “Lehman Brothers” is the trade name for a group of affiliates and subsidiaries of Lehman Brothers Holdings Inc.

Individuals may not invest directly in an index. Past performance is not indicative of future results.

The above article is for general information only and is not intended to provide specific advice or recommendations for any individual. Consult your attorney, accountant, or financial or tax advisor with regard to your individual situation.

Mutual of America Life Insurance Company is a Registered Broker-Dealer.