Stock-market investors said goodbye to 2001 with a shake of the head and a bitter "good riddance."
The broad indicators seemed to tell a depressing story for the year: The Standard & Poor's 500 lost 13 percent, while the Dow Jones industrial average lost 7 percent and the Nasdaq dropped 21 percent.
What lessons can be gained from this that will be useful in the year ahead?
First, that the stock market is treating us quite well, thank you.
That's right. Stock investing, as any financial adviser will say, is a long-term game. Though stocks can swing wildly in the short run, investors who have waited out the downturns have been rewarded with long-term gains that dramatically beat alternatives such as bonds and bank accounts. In the 20th century, stocks, measured by the S&P 500, returned about 11 percent a year, on average two to three times the return for those alternatives.
Despite the big losses in 2000 and 2001, the S&P 500 still has produced average annual returns of 10.7 percent over the past five years and 12.9 percent over the past 10 years. That's awfully good.
While no one would cheer the index's decline this year, it's likely that very few well-diversified investors actually lost a full 13 percent. How many people, after all, made all their stock buys Dec. 29, 2000? You'd have had to do that to suffer a real 13 percent loss. Most people who had investments at the start of 2001 had accumulated them over several years at least; they probably remain in the black today.
Moreover, people who continued to make investments throughout this year may have fared much better than the year-to-date figure suggests, since some investments made during dips should have racked up nice gains.
For example, I looked at what would have happened to an investor who put equal sums into the S&P 500 on the first trading day of each month in 2001. I used the Vanguard 500 index fund, the largest fund tracking the index.
Surprisingly, this investor would have lost only 2.4 percent through Dec. 27, thanks to a few bargain purchases. The biggest losses, 8.8 percent and 14.8 percent on the investments made in January and February, would have been largely offset by 11.8 percent and 7 percent gains on the October and November investments.
So the key lessons of 2001: Hanging in pays off. And dollar cost averaging works. That's the practice of religiously investing equal amounts at regular intervals, forcing you to buy when prices are down and your natural reaction is to shun the market.
This year also has demonstrated, once again, the value of spreading your eggs among many baskets. Those who were heavily invested in Enron Corp., for example, nearly were wiped out as that huge energy trading company fell into bankruptcy.
Investors who chased the big tech-stock fad in 1999 still are a long way from recovering, and likely rue their excessive concentration in those stocks.
No one knows what stocks will do in 2002, and one could argue that stocks remain overpriced. The ratio between share prices and the past 12 months' corporate earnings is a worrisome 48 for the S&P 500, triple the long-term average.
To get back to a level in the low 20s, which many experts think is about right under modern market conditions, stock prices would have to drop by half unless earnings jump. Earnings could soar if the recession ends next year, and the consensus among Wall Street analysts questioned in a recent poll was that earnings among S&P 500 companies should double in the new fiscal year.
That's a big "if." Certainly stocks are risky. And certainly it would be better to make 2 percent in a federally insured bank account if the alternative were to lose money on stocks.
But even the most recent history shows that stocks are the best long-term investment. I'm still betting that five or 10 years from now, stocks will be substantially higher than they are today. If today's prices turn out to be bargains, I'd feel pretty bitter if I'd spent a decade on the sidelines.
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