Is Investing Really a Gamble? The Numbers
By James K. Glassman

Writing about the rise of the Ownership Society in the last issue of TAE, I argued briefly with critics of Social Security reform like James Surowiecki of The New Yorker, who wrote that the "Bush plan is asking you to swap an insurance policy for a lottery ticket."

 

Games of chance are a major theme for the critics. A television ad from the AARP shows two seniors saying, "If we feel like gambling, we'll play the slots." An op-ed in the New York Times calls the President's plan "another opportunity to roll the dice in the investment casino."

 

Do these critics really believe that long-term investing is the same as gambling? Or are they, as I suspect, disingenuously trying to taint Social Security reform simply because it would haul down America's greatest socialist icon and stand up personal responsibility in its place? In either case, they are wrong to equate stocks with slots.

 

Modern investing with diversified portfolios like index mutual funds is the opposite of gambling. They will build a far more substantial nest egg than Social Security, so invested savings are much better "insurance" against penury than today's dribbling Social Security payments.

 

Let's talk actual numbers. At a casino, the odds favor your losing by a wide margin. In roulette, for example, a bet on a single number pays 35-1, while the true odds of winning are 37-1, a house advantage of about 5 percent. Gamble any length of time and you're almost guaranteed to lose.

 

In the stock market, the odds favor the investor--by a mile. Since 1926, the average annual return of the benchmark Standard & Poor's 500 Stock Index has exceeded 10 percent. Invest long enough in the stock market, and you're almost guaranteed to win.

 

The key word is "long." In the short run, stocks are very volatile. The best year for the S&P was a gain of 54 percent; the worst, a loss of 43 percent. That's a 94 percentage-point swing. The S&P has produced an annual loss, on average, every three and a half years. That's risky!

 

But the long run is very different. Look at any ten-year period for holding stocks (1926-1935, or 1927-1936, or 1928-1937, and so on up to the present). Out of all 70 ten-year periods in the modern era in the United States, stocks lost money in only two ten-year periods. The biggest decade-long loss was less than 1 percent.

 

Over longer periods, the stock risk declines below the risk of Treasury bonds, notes Jeremy Siegel of the Wharton School. It's a virtual certainty that the U.S. government will return your principal at maturity, but, along the way, the purchasing power of that money will decline because of inflation, and the interest checks might not make up for the loss.

 

Long-term investing for retirement in a personal account is the ideal way to take advantage of the special kind of risk and return offered by stocks. Since financial data collection began in the early nineteenth century, the broad U.S. stock market has never, ever, produced a loss over a period of 17 years or longer. Even including the Great Depression. Even after inflation.

 

If you start investing when you begin working, you will be a stock investor for 40 years or more. Over that time period, history shows that you'll make 7 percent (after inflation) with a 100 percent stock portfolio. With a portfolio split 50-50 between stocks and bonds you'll make 5 percent after inflation. By contrast, Social Security shows returns of about 1.5 percent for people born in the past 30 years (that's assuming the program stays solvent).

 

Our best maps are based on experience. Experience tells us that U.S. stocks--which are simply a manifestation of the U.S. economy--are an excellent bet. Yes, this country could be devastated by terrorism, or a meteor strike, or some economic calamity. But if such a disaster occurs, how sound will the promises of a government wealth-transfer program be?

 

Implicit in the idea of an Ownership Society is the notion that most people prefer to rely on themselves rather than on Washington for their economic well-being. Government has a place, including helping the poor and the sick when they can't help themselves.

 

But when it comes to providing for a normal retirement, I'd rather do it myself, thank you.

 

Especially when the odds are--by such a wide margin--in my favor.