Stocks Used to Be Bad for the Long Run

Dodging the Great Recession left me curious about money.

So, we sat down with a financial planner in 2009. Meeting with professionals sounded like what grownups did. He handed us what I now call “The Chart.”“You’ll love this, since you’re a history guy,” he said.

You’ve seen it, or a version of it. A mere $10,000 invested in the 1929 stock market, reinvesting all dividends, was now worth over $10 million! The dates change. The takeaway never does. Everything always goes up and to the right.

Now I was Curious George–level curious. The Man in the Big Business Casual showed us that when times grew dark, like depressions, burst housing bubbles, or the King of Pop dying, the stock market still eventually went up. Why? It just did. Please hold your questions till the end.

I started monkeying around with The Chart. The Man in the Big Business Casual moved from kindly, to patient, to frustrated, to annoyed. The Chart was all the proof I should need. History was on his side. I really should stop fooling with it.

The historical assumptions of The Chart were exactly what got me going bananas. There was no “mere” $10,000 then. Houses didn’t cost $10,000 in 1929. Any person dropping their life’s savings into stocks would have to live on the dividends, not reinvest.

Besides, you could not buy a stock index in 1929. The Dow Jones existed in the newspaper, but no one owned it. There were three options. You could buy every company in the Dow, but that meant buying 100 shares of 30 companies because the rules required a minimum purchase size. All those shares cost about $1 million ($12 million today). Ten thousand bucks wasn’t going to cut it. The Chart was monkey business.

Then, there was the investor. This mythical creature bought stocks in 1929, lost 80 percent, survived a depression, fought Nazis, feared nuclear Armageddon, lived through double-digit inflation, cried when Ross and Rachel got back together, but never once touched that money? How old were they in 1929?

According to the financial advisor, The Chart was proof that investing small sums over a long time got you rich. That wasn’t what I saw at all. I kept looking at it backward. The Chart showed that if you invested money you didn’t have, in a way you couldn’t do, avoiding fees you had to pay, saving dividends you certainly needed, and lived longer than you were likely to live . . . you, too, could be a millionaire by your hundredth birthday.

The Chart looks at the past, but it isn’t history. It apes history. Everything is Slow Time. In The Chart’s world, there was no inflation, no taxes, no fees, no oops babies. If I saw him today, The Man in Big Business Casual would stammer that the stock market went up seven-fold since we spoke. Overthink things and you end up curiously broke. Besides, stocks had always gone up and they always would. That was how people got ahead in this country.

But stocks didn’t always go up. Very few people got ahead with them. And overthinking things is my specialty.

* * *

The stock market was not the greatest path to wealth for average Americans for most of time. You wouldn’t know this if you spoke to any financial advisor, read any investing book, listened to any guru, or turned on any business channel. The idea that investing in stocks is how people got rich is so ingrained in our thinking that to suggest otherwise is heresy.

For much of history, though, the stock market wasn’t a very big deal, in part because there was not a market. There were dozens. New York had Wall Street, but Philadelphia, Baltimore, Providence, Hartford, and even smaller towns vied to become the leading place to trade shares. In the South, Alexandria, Richmond, Norfolk, Charleston, Savannah, Mobile, and New Orleans all had active stock exchanges. One of the busiest was in Natchez, Mississippi. Even so, most Americans didn’t live in cities, so buying stocks meant traveling or mailing funds across long, frustrating, dangerous distances.

Stockbrokers could sell you stock, but that was not their day job. One advertised that he helped find farms, houses, horses, and “carriages of any sort.” He was part stock man, part real estate agent, part used-car dealer. Another bragged he could secure poor suckers to take your place in the military draft.¹

Because the minimum transaction size was set at 100 shares, the smallest purchases often cost $10,000 or more ($250,000 today). People simply didn’t have that kind of cash. This left everyday people who wanted in to buy odd lots from expensive brokerages, set up margin accounts to use borrowed money, or most often simply bet on price swings at the local bucket shop, a local hybrid bar-gambling den. Most buyers weren’t even American citizens. They were rich Europeans.

The typical citizen’s view of stocks was that, though exciting for the imagination, they were a form of gambling.² The Supreme Court agreed. In 1906 it confirmed that states could outlaw bucket shops, effectively making it illegal for everyday people to buy stocks on margin. Since buying in cash was so expensive, governments effectively barred everyday people from buying stocks on the exchanges.³ Most Americans lived their entire lives and never owned a single share of American business.

That didn’t mean Americans missed out. In fact, they dodged bullets. Contrary to popular opinion, stocks did not beat bonds throughout history.⁴ From the founding to 1862, there wasn’t a single thirty-year period where stocks were a better investment than bonds. Over the entire nineteenth century, bonds beat stocks, and until World War II, they were about evenly split for investment returns. Yes, I have seen your friend’s social media post saying stocks always won. Your friend is wrong.

Case in point, the Second Bank of the United States⁵ was 30 percent of the entire U.S. stock market. In 1837, the price went from $120 per share to $1.50, and eventually failed altogether after Jackson’s Bank War and the nationwide Panic of 1837. This would be the equivalent today of Apple, Microsoft, Nvidia, Amazon, Google, Facebook, Tesla, Berkshire Hathaway, and Walmart all declaring bankruptcy on the same day. Gilded Age stock scams and rug pulls (getting investors into a stock and yanking its value away) were so notorious that top Wall Street investors held an 1899 New Year’s Eve party where high society lined up to shear the wool from a live lamb to celebrate fleecing ignorant investors. This was in the newspaper. They were proud of it.

Little wonder, then, that in 1899 barely 1 percent of Americans owned stocks.⁶ Why would you? They were expensive, far away, dangerous, and there were better things to do with your money. In that world, foul balls didn’t count as strikes in baseball, Teddy Roosevelt wasn’t even vice president, women’s long skirts had not started inching up their legs to help peddle the wildly popular bicycle, and everyone knew that stocks were for suckers.

Just 100 years later, in 1999, everything was different. Mark McGwire walloped 70 home runs, Bill Clinton had just been impeached, and women could wear whatever they dang well pleased. Over half of Americans in this strange new world owned stocks. It was, they said, the clear lesson of history.

What changed?

* * *

We’ve already seen that World War I inflation blew a hole through financial assumptions. Inflation became increasingly baked into capitalism’s cake. In a brief 1920s dalliance, millions of Americans jumped into stocks, but then the souffle, as novice bakers often learn, collapsed suddenly and took the joy of speculating with it. Recipes changed accordingly.

Slowly, though, Americans learned to wrap their minds around “the” market.The first transition came from pseudoscience, a phrase for combining small facts into grand truths those facts don’t fully prove. A Frenchman named Clément Juglar noticed that capitalist economies seemed to have a panic attack every seven to ten years. Englishman William Jevons took the Frenchman’s dates and compared them to nature. In a wonderful case of confusing correlation with causation, he discovered these economic tantrums vaguely overlapped with solar sunspots, which he presumed disrupted agricultural markets. The timelines didn’t exactly match up, so he dismissed some panics as not panicky enough and concluded that the average distance between market crashes was precisely 10.466 years. Jevons naturalized the business cycle.⁷

In the United States, The Wall Street Journal founder, Charles Dow, eagerly applied Jevon’s theory. Since the recently invented ticker-tape machine gave exact prices, Dow believed you could measure the stock market,⁸ and through it the economy, as a natural phenomenon. The first edition of The Wall Street Journal printed the price movement of twelve stock prices and officially branded it the Dow Jones Industrial Average in 1896. The exact number of stocks kept changing, but the idea that a standard sample of prices could measure the market took off. Standard & Poor’s index evolved from 90 stocks in the 1920s to 500 by 1957. Today there are indexes for just about everything, including an S&P Catholic Values Index.

Faith was certainly at work. Peter Hamilton, Dow’s successor at The Wall Street Journal, believed that prices revealed natural laws. Indexes measured the market “precisely as a thermometer registers heat or cold,”⁹ he explained. They were no longer speculators. They were financial weathermen.

Pseudoscience became legal after World War II. “Prudent Man Laws” required anyone charged with investment outcomes to behave as a traditionally practical person would. This meant buying bonds, real estate, and mortgages only. Stocks were, by law, too risky for prudence. But if stocks were understandable to the scientific mind, then surely a prudent man could play the market. In 1950, New York passed the first expansion to allow fiduciaries to place up to 35 percent of funds into common stocks.¹⁰ Two years later, Harry Markowitz’s landmark paper in The Journal of Finance birthed modern portfolio theory, offering practitioners proof that well diversified stocks outperformed other strategies. Prudent men went crazy for stocks.

Waves of adoption followed. Big entities started buying first: insurance companies and pension funds especially. The New York Stock Exchange (NYSE) launched its “Own Your Share of American Business” campaign targeting main-street buyers, but fees were still too high for everyday people. Then, in 1975, the NYSE eliminated fixed fees. The glide path to lowering transaction costs to $0 was on. The following year, Vanguard released their famed index fund, which for the first time allowed investors to truly buy “The Chart.” In 1994, E*TRADE offered the first public website for trading, with mind bogglingly low $14.95 fees per trade. Competition drove prices down further until Robinhood offered completely free trades, forcing others to do the same.

* * *

The same year E*TRADE arrived, Jeremy Siegel published Stocks for the Long Run, arguing that history proved stocks were always the best long-term investment. People bought the book in droves, and some suggested Siegel’s book helped fuel the 1990s stock market boom. In reality, Americans were already gobbling up stocks. Siegel just gave them their slogan.

Stock ownership was barely 20 percent of households in the early 1980s.¹¹ That rate doubled to over 40 percent before Siegel’s book hit. A few short years later, 50 percent of American families owned stocks as cheaper fees and 401(k) retirement plans gained steam. Siegel did not begin a stock market feeding frenzy any more than the Discovery Channel made fins scary in saltwater. But “Shark Week” and “Stocks Always Go Up in the Long Run” are much better branding for what excites people already.

Siegel’s book became part of the Holy Canon of Investing. People reference it without ever reading it, sometimes not even knowing it exists. “Stocks always go up in the long run” is embedded into the American mind like “A penny saved is a penny earned” or “The Mets will find a way to screw this up.” We’re not sure where we learned it. We just know it’s true.

* * *

What if it isn’t? In fact, there are many times stocks underperformed. After new sources were uncovered,¹² scholars noted that bonds beat stocks for all of the 1800s, and there were plenty of long periods of the twentieth century where stocks were just plain bad investments. The Dow was higher when my dad was a child in 1964 than when I was a preschooler in 1982.

The reality was “the market” was changing. What it used to be isn’t what it is today. Take dividends (payments investors receive out of company profits). For most of history, dividends accounted for nearly all investment returns. A company made profits, and those profits were handed over to the company’s owners. Not all dividends are the same, of course. The Dutch East India Trading Company issued returns in corn and pepper. You had to bring your own buckets: carrying costs.¹³

From the Founding Fathers to the release of Michael Jackson’s Thriller (1982), dividends were 96 percent of total stock returns. The rise in stock prices was minimal. Then, everything flipped, as if stocks had learned to moonwalk. Price appreciation became almost everything, accounting for roughly 70 percent of the money investors made. Fewer than one in five companies even bother with dividends anymore.¹⁴

There are perfectly good reasons for all of this. Dividends get taxed. Profits are better used growing the business. But the fact remains that stocks you buy online today aren’t remotely similar to what your grandfather bought. It is a new creature that keeps what it makes, and promises you that one day in the future you’ll have more.

Because of this, the other great shift in stocks is that you are no longer buying companies in any real sense. You are buying future buyers of companies. You click “Buy” on an order today because you assume some other person will hit “Buy” in the future. With few dividends to reinvest, the only way to make money is to wait for the numbers to go up. You are not buying a share of future income at today’s prices. You are buying a future buyer at today’s prices.

This means that the real value in today’s stock market is not from company profits, but from inflows of other buyers chasing those profits. In 1983, fewer than 20 million households owned stock, and they owned just a few companies each. Today more than 75 million do, and they own many more. Foreign ownership of equities also tripled; over 17 percent of all share owners don’t live here. Insurance agencies and pension plans that used to hold mostly safe assets are now overwhelmingly in stocks. Workplace retirement plans funnel billions in 401(k) withholdings to Wall Street every month. The stock market has gone up since 1983 in no small part because the number of stock buyers went up dramatically. The real profitability of U.S. companies increased¹⁵ nearly five times, but the prices of those company shares rose by over seventeen times.

Inflows are most of the investment game today. The return on stocks got better the more people believed the return on stocks was better. Faith remains an underappreciated pillar of the economy. We need people to keep believing because we need our 401(k) to keep going up and to the right on The Chart.

This phenomenon went on steroids the more trust Americans placed in the low-cost passive index funds and ETFs revolutionized by Vanguard in the 1970s.¹⁶ Since you could truly buy the whole market with tiny fees, passive funds beat active investors nearly everywhere. The personal finance industry became evangelical for indexing, preaching loudly and converting millions. The underlying assumption of index funds is that the price of the market today is always the right price because the active players have done all the hard work pricing them for you.

Indexing was supposed to be an ant on the elephant’s back, getting a free-ish ride. But, as indexing becomes ever larger, it multiplies into a giant ant army with only one order from the queen, “Buy!” At what price? “Any price!” The larger the army grows, the more it creates the value it seeks to find. Index funds are becoming an Oedipus, racing toward Thebes, proving the oracle right with every stride. The price must go up and to the right.

I’m not saying this ends in accidental murder and Freudian incest. I am saying we’ve turned the stock market into a retirement vehicle for the masses, which is not what it was originally built to do. That may work just fine for a long Slow Time. But if the ant army ever retreats, if more people want to sell their shares than want to buy them, then the order “Sell!” At what price? “At any price!” . . . will make for very interesting Fast Time history to live through.

We forget about time at our peril. What is “safe” and “sure” and “always worked” shifts over time. Timeless truths about wealth rarely last long. The more sure we become, the less safe any assumption is. I’m not a perma-bear telling you to get out of the market. I am saying that the “history” everyone says proves stocks are always good for the long run is less than a century old, which in my line of work is a rounding error.

* * *

Are you bored? I’m a little bored.

Stick with me and I’ll make it fun, I promise.

So much of this is in how we think about investments all the way back to Mr. Dow’s Index. If 1 million new people buy bonds, the prices go up. But no one talks about the prices of bonds going up. They report on the yields, which go down. That is because the guaranteed payment stays the same. A 3 percent bond purchased for $100 pays $3 each year. It could, if many more people wanted to buy it, sell for $200. The yield is thus cut in half to 1.5 percent. You still get the same $3, you just pay twice as much for it. What everyone does is buy something that is getting more expensive. What everyone sees is a return on investment that is getting lower and lower.

Stocks do the same thing, but they show the information in reverse. If more and more people want to buy a company with 3 percent profit, the price of the stock goes up and up, so your percent return goes down and down. If the price of the stock doubles, the profit per share is cut in half, the same as a bond. But nobody reports stocks this way. We just report that the price of the stock doubled. You are richer even though the return is poorer.

Let’s spice this up with one of society’s more perverse and pervasive double-standards. The way we think of bonds and stocks is a bit like the unfair ways we talk about women and men in the dating game. If a girl goes out with a lot of men, we don’t say, “Wow, she’s really desirable.” We say, “I wonder what’s wrong with her.” The potential return on that relationship goes down because it feels used. That’s bonds.

If a guy has great hair and a strong jaw line, the fact that everyone wants to be with him increases his appeal. He’s in the top 10 percent who get all the swipe-rights. We only report on his desirability, and the more desirable he is, the more desirable he becomes. Never mind the fact his returns as a new mate are actively going down. He will, after all, likely become a crappy partner fond of fawning attention. But we don’t slut shame Richard from the rich family because he looks amazing and his parents have a house in the Hamptons. That’s stocks. The more people swipe right on stocks, the more others want to own them. People rush in after the hot stock, making it hotter still.

Don’t blame me. Blame the patriarchy.

You are not the problem. He is. No, really. Most stocks are crappy partners and don’t deserve the unfair treatment they get. To explain this, I need you to meet your fabulous, financially responsible gay best friend named Treasury Bills. T-Bills always show up on time, get what you need, and help you jump off the emotional roller coaster. They provide a soft landing when the market breaks your heart. Or, in finance terms, they offer short-term liquidity and interest roughly tracking inflation. They never let you down.

Here’s the catch. T-Bill won’t procreate with you. They’re not built for it, and honestly it grosses them out thinking about it. If you’re looking to grow your money—to make it multiply—T-Bill isn’t down with that. But if you must harvest losses for tax season, they’ll help you cry it out.

Over half, 58 percent to be exact, of all stocks in American history returned less than T-Bills. Thirty-eight percent tied with T-Bills. Do the math: 58 + 38 = 96 percent. Every single dollar of excess gains from “the market” came from the leftover 4 percent.¹⁷ Since 1926, only 1,092 companies have accounted for any, ANY, ANY positive return over Treasury Bills. There are very few stocks worth leaving your platonic bestie for. Yet everyone believes “the stock market” goes up because it is natural for it to do so. The bias is baked in: men and stocks keep getting promoted because they are men and stocks.

It gets wilder. Half of the total difference between the safest thing in the world (T-Bills) and stocks came from just ninety companies. Less than one-third of one percent of all companies that ever existed are the reason stocks do well. That is 0.003. The top thirty companies accounted for a full third of all stock market gains. Most stocks may look good, but they’re dead weight.