In 2001, Warren Buffett (Trades, Portfolio) gave a lecture at the Terry College of Business at the University of Georgia. In it, he broke down the previous 100 years of American financial history into six distinct periods — three periods of stagnation, and three roaring bull markets. Here is what we can learn from history.
A brief history lesson
Buffett characterized these periods based on the returns of the Dow Jones Industrial Average over a particular length of time. The periods are as follows:
1900 to 1921. The stock market barely moved over more than two decades. The Dow went from 66 points to 71 points (how quaint!). This equated to a less than 10% move over this entire timespan, yielding returns of less than 0.5% annually (excluding dividends).
1921 to 1929. The Dow took off, going from 71 to a high of 381, a total return of 536%, over that (much shorter) period.
1929 to 1948. The Great Depression and World War II were exceedingly difficult times for stock market investors. The Dow went from its Gilded Era high of 381 to about 180 — a 47% decline over that time period.
1948 to 1966. The postwar economic expansion translated to gains in the financial markets, with the Dow returning 550% as it roared from around 180 points to 990 points.
1966 to 1982. During this 17-year period, the Dow traded between 600 and just below 1,000, meaning that investors who had bought the top of the previous bull rally were underwater on their investments (and presumably most preferred to cash out rather than sit on their paper losses).
1982 to 2001. In 1982, the Dow broke through the 1,000-point level and never looked back. I am choosing 2001 as the cutoff point here because that was as far as history had gotten at the time the lecture was recorded, but it is an appropriate point in time to choose for other reasons. Between the early '80s and early 2000s, the Dow returned roughly 1,110%, which, compared to the previous historical periods, was a truly staggering amount.
Almost two decades have elapsed since Buffett gave that lecture. Accordingly, I propose adding three more (shorter) time periods.
2001 to 2003. The short-lived bear market (if you can call it that) of the early 2000s saw the Dow lose 27% of its value from its height during the dot-com bubble, settling around the 8,000-point mark.
2003 to 2009. This period saw the Dow return almost 175%, with the index topping out around 14,000 on the eve of the financial crisis. As we all know, this was followed by a precipitous drop to a low of 7,000, meaning that someone who invested their money at the height of that bull market probably lost close to 50% of their invested capital.
2009 to today. Since 2009, the Dow has been on a tear. Just this summer, it recorded an all-time high of 27,359 points, a roughly 390% return over that decade, which puts it on par with the other bull markets in terms of annual returns.
Should you buy and hold?
What, you may ask, is the point of this history lesson? Well, you’ll notice that in the 20th century, more than half of the years in the market were periods of stagnation. Moreover, there were significant periods of time (decades!) in which investors lost money. You will often hear that investing in the stock market is preferable to holding cash because of the magic of compound interest. That is only part of the story. Compounding only works if you do not lose money.
For instance, someone who invested their money when the Dow was at 14,000 in late 2007 would have had to wait for five years for their investment to come back to where it was on the day that they made that ill-fated decision. During that five-year stretch, our hypothetical investor would not have experienced the benefits of compounding.
Much investment advice ignores this nuance. It takes average annual returns and assumes that invested capital does not undergo down years. You may hear advice that tells you to just buy and hold, because it is impossible to time the market. And while it certainly is very difficult to time the market, knowing when something is overvalued is not. So buy stocks for the long haul, certainly, but always be wary of buying something expensive. You may have to wait a long time for that pension plan to recover. Knowing when to buy is as important as knowing what to buy.
Disclosure: The author owns no stocks mentioned.
Read more here:Â
Mohnish Pabrai: What Investors Can Learn From EntrepreneursÂ
Stanley Druckenmiller: Algos Have Changed the Way Markets Send SignalsÂ
Is Today’s Monetary Policy Effective?Â
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
