Arnold Kling

Stocks not Risky?

Arnold Kling, Great Questions of Economics
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The Economist does a nice job of explaining a new study by Elroy Dimson, Paul Marsh, and Michael Staunton of an old issue: are stocks a better investment than bonds over the long run? The answer is, "yes."

In every country in their study, the authors show that real (that is, inflation-adjusted) returns from equities beat bonds.

The implication of this sort of research is that you should buy and hold stocks, rather than trying to time the market. Even when stock prices appear to be "high," it is a good time to buy.

I myself cannot resist market timing. These days, I am prepared to add to my portfolio of U.S. stocks whenever the Dow falls below 9000, and I am prepared to reduce my holdings whenever the Dow goes above 11,000. In between, I stand pat, at a relatively low level of stock market investments.

I know that the research tells me that I am wrong to try to time the market. My "timing" strategy leads me to have too little of my portfolio in the market on average, and I can see where my wealth is lower than it would have been had I just bought and held all along. But as convincing as the research seems to be, I cannot make the move to buy and hold.

Discussion Question

So-called behavioral economists emphasize the irrational components in human behavior. Am I an "exhibit A" for behavioral economics?

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