Some of the best investments – the ones we dream about as market observers – are those that provide substantial recurring cash flows for many decades into the future. This is really the ultimate underlying goal of growth, dividend growth and value investing equity strategies. And proponents of these strategies will claim, to a man, that choosing these stocks is both easy and lucrative. However, this assertion is one of those devious lies that is so compelling because it contains a bit of truth. Just a handful of stocks have given their fortuitous owners very high returns over long periods of time. I wish the aspiring millionaires of the world good luck picking out those specific companies beforehand, though.
Let’s look at an example: Coca-Cola stock. If you had invested in this iconic American company during its IPO in 1919, you would have come away with a stellar annualized return of 14.27% (dividends reinvested through 2015). Sounds great, right? Except, as the incredulous among us already know, the real world doesn’t work that way. For one thing, for every company that performs to the exceptional level of a Coca-Cola, there are at least a hundred companies with far more pedestrian returns and another hundred companies that never make any money.
So let’s construct a hypothetical stock portfolio that reflects this reality: 1 superb company, 200 mediocre companies and 100 failures. We’ll assume our superb, Coca-Cola like company returns 14.27%, while our mediocre companies return 5% and our failed companies return nothing. Once we run the numbers we find that our real life stock portfolio returns a less than inspiring 3.37% per annum, assuming annual rebalancing.
Let’s compare this more realistic stock portfolio to my preferred asset class: investment grade art and antiques. While performance data is notoriously difficult to find for this asset class, I have cobbled together a return calculation using the 1912 edition of the Sears mail order catalogue. In particular, I chose a women’s Elgin pocket watch (size 6) with a 15 jewel movement and a solid 14 karat gold hunting case. This pocket watch sold for $27.60 in the 1912 Sears catalogue and would have been considered a good, but not great, timepiece during the period. To estimate a current value, I checked eBay for similar watches that sold in the past few months and determined that $900 was a reasonable price.
Upon running the numbers I found our watch’s performance over the last 104 years was 3.41% a year – on par with our real life stock portfolio. Of course this equivalency charitably assumes the mediocre companies in your stock portfolio stay in business for 104 years! But that isn’t the end of the story. You see, I rarely advocate buying new luxury goods as investments. They generally cost too much to make sense as investments. The secondary market is a much better place to pick up investment grade art and antiques for cheap. If we apply this dictum to our pocket watch, the story changes a bit.
I assume that 10 years after the watch was originally sold (1912) you could have purchased the same piece second-hand (in 1922) for 60% of the original purchase price ($16.56) and then spent a generous $4 on servicing it. These are not heroic assumptions; on the contrary, they are actually quite modest. I’m sure any half-way competent fine art investor could have done considerably better. Anyway, our new return number is 4.1% over 94 years, a clear win over our real life stock portfolio.
“But wait!” I hear you cry. “Your real life stock portfolio wildly understates equity returns because indices like the Dow Jones Industrial Average and S&P 500 have performed far better than this for many decades!” Ah yes, the good old lie of the index. First, indexes are not truly passive. They change constituents on a regular basis, usually once a year. “No problem.” you reply, “I’ll just invest in an index fund to mimic their results.”
Investing in index funds is a great idea. Or, I should say, it used to be a great idea. Passively investing in an index wasn’t possible until stock market guru John Bogle made it a reality by establishing the Vanguard 500 fund in 1976. There simply weren’t any available investment vehicles in existence similar to an index before this time. I readily admit that passive index investing was a phenomenal idea in the 1970s, 1980s and into the 1990s. But then passive investing became conventional wisdom. And once a concept becomes conventional wisdom it rarely remains a good idea.
The popularization of passive index investing has created two ironic effects. First, it has caused indices to perform better since the late 1990s than they would have otherwise. All passive investors, by definition, buy shares in index companies, thus driving up demand for those stocks. This boosts the prices of these index stocks specifically and the broad indices more generally. Second, the broadly overvalued indices that result from this indiscriminate, passive investment demand invariably lead to poor future performance. After all, the most important attribute of any investment is the price you pay for it. Buy it cheaply enough and even an otherwise unremarkable company becomes a winning investment. Likewise, overpaying for even the finest of companies will result in subpar investment returns.
Investment grade art and antiques suffer none of the guessing games inherent in the stock market. The layman can easily choose antiques that adhere to the five principles of investment grade art: as large as possible while preserving portability, quality materials and construction, durability, scarcity and stylistic zeitgeist. If you follow these simple rules when investing in antiques you can readily achieve 3% to 5% returns – although probably much, much better – compounded effortlessly over a century or more with implicit inflation protection. In contrast, the average lifespan of a company in the S&P 500 index today stands at only 15 to 18 years. That seems like an exercise in guaranteed frustration for stock investors as they scramble to cycle flavor-of-the-month stocks in and out of their portfolios in rapid succession. And the more buy or sell decisions an investor is faced with, the greater the chances he will make one or more crucial errors. It is clear to me that art and antiques are the better, safer way to build long term wealth.
