The book’s historical context has changed significantly since it was written. Unlike the current boom in technology equities, industrial stocks were one of the most popular investment objectives of the year.
In contrast, there was a recent bubble burst in railroad stock prices.
Gold’s price was still linked to the US dollar at that time. Back then, people didn’t rely on computers to go online to acquire the most recent quotes, so you could swap a fixed dollar for gold.
There isn’t an ETF accessible to diversify your investments.
You might need to hunt for the financial report information in some publications if you wish to check it.
And it is not as complete as it is now that the financial accounting system.
As a result, stocks at the time (1920s) were still seen as highly speculative.
At the time, investing in bonds with a set interest rate return was more common than investing in equities.
During that time, commercial paper yields were between 4% and 10%, while ten-year U.S. Treasury yields were roughly between 4% and 5%.
Consider stocks to be risky? It probably sounds familiar to a lot of folks.
It has gotten much easier for people to acquire stock market information even now, over a century after the book’s publication, and many businesses likewise revolve around our lives.
The stock market is risky, you still hear a lot of people claim.
But is it actually true?
To show that the stock market is not as deadly as people believed, the author intended to publish this book.
Bonds have less turbulence. Can cautious investors solely make bond investments?
Bonds are frequently referred to as fixed-income securities. Their expectations for a return are, as the term suggests, fairly certain.
In exchange for not defaulting after purchasing a bond, the creditor will continue to earn fixed interest and return the principle at maturity.
The danger of price changes is frequently substantially lower for high-quality bonds than it is for stocks.
People who invest in bonds typically earn relatively high certainty returns and are less concerned about fluctuations in bond quotations as long as they avoid buying high-risk bonds.
If you deposit a certain amount of money in a bank today, the bank will use the money after receiving it to lend out loans and make investments. Financial institutions should focus on funding bonds with highly deterministic yields, such as short-term government bonds. For banks, these bonds are the same as cash. Even with a very low rate of return, it is still a sizable quantity of money for a financial institution with hundreds of millions of dollars in assets.
Sounds like a sure bet to invest in top-notch bonds, even with a slightly lower return?
However, there is a drawback to bond investing: Bonds are difficult to beat against inflation risk.
A 1% to 3% annual inflation rate doesn’t seem like much. It might result in a loss of 10,000–30,000 for a person with $1 million in assets.
However, if you work hard and eventually amass 50 million in assets, the annual wealth loss from inflation will range from 500,000 to 1.5 million. Although earning interest from bond investments is possible, the interest itself must still be subtracted from inflation, which is the true increase in investors’ purchasing power.
The fundamental reason why stocks do substantially better in this regard is that businesses can modify their pricing to reflect inflation. It’s not like bonds can accomplish anything, but this cannot entirely counteract the negative effects of inflation. And inflation has happened more frequently in history than deflation. Additionally, over time, bonds pay less than stocks.
The central thesis of this book is that equities outperform bonds in terms of long-term returns.
It is a given in this argument that stock returns outperform bond returns when the investment horizon is long enough.
Only compare returns; disregard volatility risk.
The idea is to diversify your investments rather than relying solely on one tranche of stocks because equities have a higher long-term return than bonds.
Additionally, sufficient time must elapse. The return of the stock market is nearly entirely better than that of the bond when the volatility risk is ignored, and the longer the statistical time period, the more likely it is that the stock market’s overall return will outperform the bond.
On the other hand, this figure is not necessarily accurate if just short-term investments are taken into account or if you only gamble on a small number of equities.
Although stocks offer better long-term returns than bonds, achieving the so-called long-term requires at least 15 to 30 years of prior experience in order to generate results with a reasonable degree of reliability.
And winning isn’t enough; if it’s a little win, consumers could still prefer to invest in bonds with lower volatility.
In the long run, historically, stocks have outperformed bonds by a bigger proportion; however, the margin of victory varies throughout different time periods, sometimes being greater and other times being smaller.
How should we invest then?
This idea is actually not quite similar to investing in stocks versus bonds when risk is taken into account.
The book focuses primarily on the characteristics of stock returns while paying little attention to stock risks.
This book was extremely popular at the time, and some claim that it was the catalyst for the 1929 stock market bubble burst and the ensuing Great Depression as a result of drawing an excessive number of ordinary investors into the market.
The actual long-term outcome of investment is not what we see right away; rather, you have to go through every fluctuation process, and when the risk is too high, it could be challenging for individuals to execute.
Bond inflation risk can be reduced by keeping a diverse portfolio of stocks over a long period of time.
Holding bonds helps lessen the uncertainty brought on by holding stocks. Although they are not at opposite ends, you can have both without creating a conflict, just like in grayscale or spectrum.
Additionally, the author still did not have access to ETFs as a useful investment instrument, therefore the author still had to use certain significant stocks as statistical samples when conducting several tests and verifications.
We may now own several financial items directly using ETFs, such as stocks and bonds, so we don’t have to be as bothersome.
Investment matters should be open to debate but thoroughly vetted
Investment fallacies abound in every period.
Stocks will do better than bonds over the long term, according to current thinking, which is nearly common sense for investors.
But it wasn’t a widely accepted consensus at the time the author of this book penned it.
The book makes extensive use of statistics to show that equities outperform bonds over the long term, and the methodology is rather rigorous.
In actuality, conducting an analysis based on data logic back then was exceedingly challenging.
Simply collecting correct data is a very major difficulty in the age before computers.
However, the author continues to use long-term data spanning fifty years, account for dividends, and take ex-rights into account when calculating the optimal investment return.
The author’s rigorous testing mentality is the aspect of this book that is most worth understanding.
If you have come across numerous financial misconceptions and are unsure of why, perhaps the author’s method of solving the problem in this book can inspire you.