How wealth can be created in stocks

A 200 year history of stocks, bonds and gold

In a study conducted in the U.S.A it was found that over a longer period of time Stocks outperformed all asset classes, followed by bonds then gold. Bonds were the most consistent while stocks and gold were erratic. Gold never did enough to beat inflation while bonds did only slightly better. The following table indicates how stocks have been the best performing asset class over the past two centuries

Source: Ibbotson Associates and Jeremy Siegel, Wharton Business School

Key Observations:

1. One dollar invested and reinvested in US companies since 1802 would have accumulated a total nominal return of nearly $8.8 million by the end of 2001
   
2. The inflation adjusted return of that dollar would have been early $600’000.
   
3. Inflation takes away $8.14 millions or 1.44% (8.32%-6.88%) of annual return. Clearly inflation is our biggest threat to creating wealth.
   
4. Treasury Bills fared slightly better by providing 3.5% and 2.9% of inflation adjusted real rate of return.
   
5. Over a period of 200 years Gold and the Dollar with real rate of returns at -.001% and -1.3% moved more or less in line with inflation. In other words you could not have become rich by buying these asset classes
   

Inspte of the data provided above why is it so that the typical Indian fancies gold, bonds and real estate to equities? There are no clear cut answers and some soul searching that I did led me into the following conclusions:

1) Since stock quotes are available on a day to day basis they manage to create maximum amount of fear and panic amongst investors.

2) Liquidity in stocks is another reason for people to get out early. Almost all of us have ancestral homes running into more then 50 years and sometimes going as high as 70 to 100 years. The reason why we held on to them was there were no two way quotes available from 9.55 to 3.30 on all week days. Compounding works O.K for shorter periods of time, but creates magic over the long term. No wonder Einstein called it the eighth wonder of the world.

3) Gold has become a symbol of emotional bondage we often relate to gold with a sense of historical nostalgia – the old wedding ring, the first bracelet that your father gifted you. These are things that we do not sell and the first stock that your father gave you was sold the moment it went up 20%.

So the point that I am initiating this debate on is that stocks are the only way to long term prosperity and it would make sense for investors to take some risk create more space for stocks in their asset allocation model the next time they sit with their Financial Advisor.