As stocks rally, stay real about the riches the market can deliver

What’s perhaps the most important investment lesson I can draw from 38 years of tracking the performance of investment newsletters? Get real.

On June 30, 1980, I first began tracking newsletters in my service, the Hulbert Financial Digest. At that time, the Dow Jones Industrial Average DJIA, +1.31%  traded below 900 and the 10-year Treasury TNX, +1.02% yielded more than 10%. Much about investing has changed since then, but a lot is still the same.

The most important, timeless investing lesson is that annualized U.S. stock-market returns in excess of 20% to 25% are not sustainable over the long term. In truth, the highest percentage rate of return that is realistically attainable over the long-term from U.S. stocks is around the mid-teens.

Consider the investment newsletter that has made more money than any other on my monitored list: The Prudent Speculator, edited by John Buckingham. When I started following this newsletter in 1980, it was edited by Al Frank; Buckingham began working at the newsletter in 1987.

According to my company’s calculations,The Prudent Speculator’s average recommended portfolio has produced a 14.89% annualized return since 1980, versus the Wilshire 5000’s total annualized return of 11.42%.

When I’ve presented this result to financial advisers, they’ve typically had two reactions — both of which are wrong:

One reaction is that the Prudent Speculator’s performance is disappointing. In fact, it’s more than enough to make you rich beyond the dreams of avarice, to quote the famous line from Samuel Johnson: for example, $100,000 invested for 38 years at 14.89% per year grows to more than $19 million.

Another reaction is that this “modest” return goes to show that newsletters aren’t worth following, since other advisers have done much better. In fact, they haven’t. The best-performing stock mutual-fund over the same 38-year period — Alger Spectra Fund SPECX, +0.87%  — produced a 14.74% annualized return, about the same as the Prudent Speculator. Warren Buffett, CEO of Berkshire Hathaway BRK.A, +1.06%BRK.B, +1.11% and widely considered to be the most successful investor of the modern era, has done moderately better — but the net asset value of Berkshire Hathaway stock over the past 38 years has still grown at below 20% annualized — 18.49% annualized, to be exact.

What I have found over the past 38 years is that one of two things must be true whenever an adviser claims to have produced returns that are significantly higher than 20% annualized. Either the return is being measured over too short a period of time to be meaningful, or he’s lying. And regardless of which of these two things is true, you should run, not walk, away.

This investment lesson and corollary are especially important now, after many years of a powerful bull market. That’s because, as the memory of the last bear market recedes, investors have moved towards the greed end of the fear-versus-greed spectrum. Financial advisers tell me that it’s become harder and harder to entice clients with the prospect of returns that are at all realistic.

Bear markets, from this perspective, serve the valuable purpose of teaching investors about risk and reality. You will pay a heavy price if you don’t get real now. Anyone who believes it’s their God-given right to earn stock returns in excess of 20% annualized will take on riskier and riskier investments when that expectation falls short. And when the U.S. market does turn down, these high-risk strategies will lose big.

For more information, including descriptions of the Hulbert Sentiment Indices, go to The Hulbert Financial Digest or email [email protected] .

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