In volatile times, stocks
still have long-term promise

On Investments
By Jeff Kane

I am saving for retirement, which is at least 10 years in the future. With all the volatility we’ve seen recently, can you give me one good reason to invest in the stock market instead of enjoying the safety of being 100-percent invested in government bonds?

Investors know that stocks and bonds are two of the most basic investment vehicles available. And anyone who has invested in stocks knows that they can play a key role in a successful wealth-building strategy over time.
While stocks are favored by day traders and others looking to make quick profits on short-term price movements, long-term investors should also realize that investing in stocks offers many advantages.
For starters, stocks have historically outperformed other long-term financial assets. In addition, stocks have typically outpaced inflation, which helps investors counteract its detrimental effects on their portfolios. To illustrate these points, the results of a recent study by two North Carolina State University researchers, Jack W. Wilson and Charles P. Jones, provide empirical data to support what investors have long suspected.
The recent analysis compared the results of investing one dollar in each of several different asset classes — common stocks, long-term corporate bonds, long-term government bonds and Treasury bills — on the last day of 1919 and holding the investment (with associated returns) until the end of 2006. All proceeds were reinvested, which means that dividends were used to purchase additional shares of stock, while interest payments from bonds were used to buy more bonds.
Investors likely won’t be surprised to find that over the course of the 87 years studied, stocks significantly outperformed several fixed-income investments. But what may be eye-opening is the extent to which they exceeded the return on bonds.
While an initial investment of one dollar in Treasury bills would have grown to about $29, the same investment in long-term government bonds would have grown to approximately $87, and a similar investment in long-term corporate bonds would have grown to more than $162.
That initial one dollar invested in common stocks, on the other hand, gave the investor a portfolio valued at more than $4,889 at the end of 2006.
The numbers alone show stocks winning this contest by a large margin. But what’s interesting is how such dramatic growth was achieved. Capital appreciation alone caused the $1 investment in stocks to grow to $137 by the end of the period. The other $4,752 came from collecting the dividends paid over the years, using them to purchase more shares of stock, and enjoying the benefits of compounding growth as well.
As these numbers show, patient investors who buy stocks that pay dividends — especially growing dividends — and reinvest those dividends in more issues of stock have the opportunity to significantly outperform fixed-income investors.
Beyond just the growth of the different investments, the effect of inflation on each of the assets mentioned needs to be taken into consideration as well. Using an average annual inflation rate of 2.5 percent over the time frame, the average inflation-adjusted returns were: 1.38 percent for Treasury bills; 2.66 percent for long-term government bonds; 3.40 percent for long-term corporate bonds; and 7.52 percent for common stocks.
While past performance does not guarantee future results, as you can see, the stock investor was the only one who was able to generate meaningful returns to combat the eroding effects of inflation.
In addition to the returns that stock investing can provide, investors should consider the tax benefits of buying stocks. When a stock is sold, the owner is subject to capital-gains taxes on any earnings from the sale.
Because of legislative decisions in the past several years, tax-advantaged investments have become even more important.
In 2006, legislation reduced the top tax rate for long-term capital gains from 20 percent to 15 percent until the year 2011. Under the same legislation, taxpayers in the 10 percent and 15 percent brackets will be taxed at only 5 percent on long-term capital gains realized before Jan. 1, 2008, and those same taxpayers will owe no taxes on long-term gains during the current year.
These are just a few of the many reasons to consider investing in stocks. Take a look at your holdings and decide whether stocks might be welcome in your portfolio. ••
Philadelphia resident Jeff Kane, CFP, associate vice president-investments, is a financial planner with the Horsham office of A.G. Edwards & Sons Inc. Questions may be submitted by calling Mr. Kane at 215-659-2500, ext. 126, or by fax at 215-659-8041. Visit his Internet home page at home.wachoviasecurities.com/jeffrey.kane