Equities reward patience and discipline, offering potential long-term wealth creation to those who stay the course.
If there is one lesson our decades of investing experience has reinforced (the first edition of The Prudent Speculator was published in 1977) and our study of market history has confirmed, it is this: equities, despite their storms and setbacks, remain the most effective long-term wealth-building vehicle available to the individual investor. Stocks represent partial ownership of businesses, and over time, businesses grow. They innovate, increase earnings, raise dividends and reinvest profits. Investors who own shares participate in that value creation.
Yes, the path to success will include rough patches. We have lived through recessions, wars, contentious elections, inflation scares and speculative bubbles. We remain steadfastly optimistic about America’s future and, specifically, our stocks, and note they have been climbing the proverbial ‘Wall of Worry’ for decades and overcoming every obstacle along the way.
The magic of compounding rewards time in the market, not market timing. More often than not, the most meaningful gains follow periods of turbulence when pessimism is widespread, volatility is high and expectations are low.
The key is to remain engaged, not retreat to cash or abandon ship amidst uncertainty. Investors often lose far more in the long run by sitting on the sidelines awaiting the “next” crisis than they would by simply riding out the downturns.
WHAT IS A SHARE OF STOCK?
When you purchase a share of stock (also called “equity”) you are not buying a lottery ticket or wagering on the market. You are buying a claim on a company’s future earnings and assets. In effect, you become a part-owner of that business, with the rights, risks and responsibilities.
This is why we favor the term ‘equity investing’ instead of playing the market. You are not chasing headlines or momentum. You are a partner, offering your capital in exchange for potential value created through innovation and growth.
Classifying Stocks
From style and valuation to size and geography, understanding how stocks are classified helps investors build their portfolios.
COMMON VS. PREFERRED STOCK
Equities usually come in one of two forms. Common stock is the most familiar. It represents ownership in a company and typically carries voting rights. Common shareholders can benefit from price appreciation and may receive cash payments (dividends).
Preferred stock is a hybrid security. Most offer fixed dividend payments and have priority over common shares in the event of liquidation. However, preferred stockholders rarely have voting rights and often forgo the same upside potential. In essence, preferred holders trade greater capital gain prospects for more predictable income and a higher claim on assets.
THE BIGGER PICTURE
Stocks do not exist in a vacuum. They are part of a broader investment universe that includes bonds, cash and alternatives (see Figure 1). Each plays a distinct role in shaping long-term outcomes. While we have a strong conviction in the wealth-building power of equities, they are not a one-size-fits-all solution.
Cash and high-quality fixed income serve important purposes in a portfolio. They provide liquidity for near-term spending needs, function as a buffer against market downturns and help reduce overall volatility. Real estate and alternatives can help diversify return sources and hedge in ways that equities alone may not.
The key is balance. The right mix of asset classes will look different for every investor, shaped by factors such as age, objectives, risk tolerance and income. Ultimately, asset allocation is not about chasing the highest returns in isolation but about constructing a portfolio that works in harmony with an investor’s unique financial plan.
For over 48 years, we’ve guided our clients with disciplined planning and personalized strategies, as they pursue their unique goals—no matter the complexity. If you’re seeking a trusted partner for your financial journey contact Jason Clark, CFA at jclark@kovitz.com or 949.424.1013.
The Case for Equity Exposure
Growth, income, liquidity and resilience; equities remain the cornerstone of building and preserving long-term wealth.
Stocks can be grouped and analyzed by a wide range of characteristics. These classifications allow folks to shape their portfolios around specific risk profiles and return drivers, creating intentional exposure to desired market traits.
BY MARKET CAPITALIZATION
One of the most common ways to categorize equities is by market capitalization, or market cap (the total value of a company’s outstanding shares). Large-cap stocks, generally worth more than $20 billion, tend to offer stability, global reach and regular dividends. Mid-cap stocks, valued between $2 billion and $20 billion, often strike a balance between growth potential and maturity. Small-cap stocks, with market values below $2 billion, can include overlooked or emerging companies capable of sharp advances or steep declines.
Research from Morningstar and Ibbotson Associates shows that small-cap stocks have historically outpaced large caps since December 1925, delivering an average annualized return spread of 12% to 10%. Over 1,076 rolling 10-year time windows, small company stocks have outperformed large company stocks 63% of the time. Of course, smaller companies tend to experience greater price swings, requiring patience and conviction to ride out a full market cycle.
BY GEOGRAPHY
Stocks can also be classified by geography. Domestic stocks are U.S.-based and benefit from deep markets and robust regulation. International developed markets such as Japan, the United Kingdom and much of Europe offer diversification and access to world-class companies. Emerging and frontier markets lack some of the safeguards familiar to U.S. investors but may offer higher long-term growth potential.
We generally favor a blended approach. Many U.S.-listed companies derive a substantial share of their revenue overseas. For instance, 36% of Russell 1000 index revenue came from abroad in 2023. By contrast, the small-cap-focused Russell 2000 earned just 24% of its revenue abroad that year. This blended approach allows investors to benefit from global growth while keeping shareholder protections investors value.
BY STYLE
Among the many ways to slice and dice the market, we prefer to use valuations and fundamentals. Our favored group is Value stocks, which typically trade at lower valuation multiples with dependable cash flows and modest expectations embedded in their prices. We believe these companies are well-positioned for the upside when the market eventually acknowledges their worth. Growth stocks, on the other hand, generally carry higher earnings potential, reinvest most profits and command richer valuations.
The line between Value and Growth is not black and white. Professors Eugene Fama and Ken French began with a single measure: the book-to-market ratio. A high ratio suggests a Value tilt, while a low ratio points toward Growth. Their research evolved into the Fama-French Three-Factor Model, which has a market risk premium (returns above the risk-free rate), small-minus-big (small vs. large cap performance) and a Value factor based on book-to-market spreads.
INDEX METHODOLOGIES
Index providers use their own formulas to classify stocks. Russell considers book-to-price ratio, forecasted earnings growth and historical sales growth, assigning each stock in their universe both a Value and a Growth score. Some companies fall entirely into one camp; others are split proportionally. S&P considers book-to-price, earnings growth and sales growth, but considers stocks to be Value or Growth with no overlap. The indexes are reshuffled on a fixed schedule.
TPS VALUE INVESTING IN PRACTICE
In the first edition of The Prudent Speculator, published in March 1977, Al Frank described our approach to Value investing as “buy low and sell high.”
He explained, “Low refers to undervalued (in the market place) stocks, and high refers to fully- or overvalued stocks. These valuations are based upon historical, current and projected: 1) tangible book value; 2) net working capital; J) price/earnings ratio: 4) earnings; 5) dividends and dividend policy; 6) price; 7) earned on net-worth percentage: 8) other special considerations unique to the company being analyzed (e.g., management, products, cultural trends); 9) stock market climate: and 10) the individual’s needs, capacities, and portfolio. I include items 9 and 10 in the notion of valuation because it is silly to consider any equity independently of them. Thus, any recommended stock is in an individual- and market-dependent context.”
IN THE PRESENT
Today, our philosophy remains grounded in that original Value-oriented framework, even as our process has evolved to incorporate modern tools, a broader stock universe and additional factors. We begin by evaluating six core metrics across the entire market, plus two additional factors that we use when they are available. The bonus factors aren’t applied universally, so we don’t want to penalize companies that lack the data.
After distilling the universe into a group of Value candidates, we apply a forward-looking model to generate 3-to-5-year Target Prices. These estimates incorporate earnings forecasts, relative valuation multiples and our own internal expectations. From there, we conduct multiple rounds of qualitative reviews to validate or revise assumptions, with any portfolio changes brought to a formal vote by our Investment Committee.
Much has changed since those early typewritten editions of The Prudent Speculator, but our commitment to identifying undervalued stocks with long-term upside has stayed the same. A review of every stock we’ve ever recommended (full list and methodology available here) shows that 62.56% were eventually sold at prices above our initial recommendation. That figure excludes dividends, which when included pushes the success rate even higher.
In the end, whether we are comparing companies by size, geography or style, our aim is always the same: to identify businesses trading below our estimate of their future value with the potential to reward patient shareholders. Classifications and academic models help us organize the market, but they are tools (not substitutes) for a disciplined long-term approach. We believe that a focus on a diversified portfolio of Value stocks offers the best chance to achieve one’s long-term investment goals.
And in general, equities offer advantages that cash and bonds simply can’t match over the long term. While cash provides safety and short-term access, and bonds offer income and stability, stocks deliver growth, income and the power to protect purchasing power.
Over the past century, equities have stood out as the most reliable engine of wealth creation available to all investors. Cash offers safety and access, and bonds provide income and stability, but stocks combine growth, income and resilience in a way unmatched by other asset classes. Their role in a portfolio extends beyond capital appreciation, though, as equities also deliver valuable attributes such as dividend income, protection against inflation and liquidity.
DIVIDEND INCOME
Dividends are a stream of cash and often serve as a tangible sign of financial strength. Companies with consistent and growing payouts typically reflect sound fundamentals, disciplined capital allocation and confidence in future earnings. The reinvestment of those dividends can significantly boost long-term wealth, as compounding works not only on capital gains but also on the growing stream of income.
INFLATION HEDGE
Unlike bonds, which pay a set return that can be eroded by rising prices, businesses can adjust prices and increase revenues in response to inflation. This ability to pass along higher costs helps protect an investor’s real spending power and supports the long-term preservation of wealth.
LIQUIDITY
Publicly traded stocks are among the most liquid investments available. Investors can buy or sell shares during market hours, providing ready access to capital when needed. This flexibility is particularly valuable for those who may need to rebalance, raise cash for opportunities or address unexpected expenses.
OWNERSHIP MENTALITY
Equities grant actual ownership in a business, aligning the shareholder’s interests with the success of the enterprise. This ownership perspective encourages investors to focus on fundamentals such as earnings, strategy, innovation and competitive positioning, rather than being overly influenced by the day-to-day share price fluctuations and other noise.
OVERALL INVESTMENT RETURNS
Assessing equity performance involves more than reviewing a single return figure. We consider multiple perspectives (total return, financial goals, consistency, dividends, et cetera) to gain a full understanding of both the opportunities and the risks embedded in a portfolio. This broader view reinforces why equities, despite their ups and downs, have been the cornerstone of long-term wealth creation.
LONG-TERM GROWTH
One of the best ways to see the power of equities is to examine their long-term growth. Since 1926, the S&P 500 has delivered an average annual total return just above 10% (including dividends). That means $100 invested in 1925 would have grown to nearly $2 million by June 2025 if left untouched and reinvested along the way. This long horizon smooths out short-term volatility and underscores the compounding effect that makes equities so powerful over decades.
PROBABILITY OF SUCCESS
The probability of success reflects how often returns have been positive across different holding periods. In Figure 3, shorter horizons (1 year) appear at the bottom and longer horizons (30 years) at the top. Starting from the year of investment along the bottom axis, moving upward shows the results for progressively longer investment periods. Red boxes indicate periods where the index lost value (not including dividends), while green boxes indicate the index gained.
ROLLING RETURNS
Instead of looking at only start and end dates, rolling returns show how investments performed over overlapping time periods. For example, one might measure every ten-year period from 1926 to today. This approach reduces the distortion that can occur when results are dominated by a particularly good or bad year at the start or end of the period. For U.S. stocks, 10-year rolling returns have been positive the majority of the time, even when sub-periods included negative returns.
EXCESS RETURNS
Raw returns can be compelling, but they often don’t show how equities fare against realistic alternatives. For investors, one of the most relevant benchmarks is the return from holding cash or cash equivalents over the same period. This comparison helps answer an essential question: Was is worthwhile to own stocks compared to simply staying in cash? In Figure 5, we show that equity returns are compelling, even relative to cash, especially for longer holding periods.
RETURNS IN EXCESS OF INFLATION
Inflation quietly erodes the purchasing power of investment gains. Real returns strip out the effect of inflation to show actual growth in spending power. For example, while the S&P 500 has delivered a 10.4% annualized in nominal terms since 1925, the inflation-adjusted return is closer to 7.5% (shown in Figure 6). Over many decades, this difference is significant. Viewing returns in real terms ensures investors are focusing on wealth creation that keeps ahead of rising prices.
ALLOCATIONS
Equities tend to support long-term goals, as growth over many years can overcome temporary market setbacks. Funds needed soon are better suited for cash or quality bonds, while objectives further in the future tend to benefit from a heavier weighting in stocks. The right mix depends on both the time until the funds are needed and the investor’s tolerance for volatility. Figure 7 provides a general framework for aligning time horizons with asset allocation.
EMOTIONS
DALBAR’s annual Quantitative Analysis of Investor Behavior (QAIB) shows that the average investor underperforms the market, not due to poor investment selection, but because of poor timing, often influenced by emotions. Investors tend to chase performance by buying after markets have risen and selling during downturns.
Figures 8 illustrates how a small difference can turn into a large gap, simply by not staying with stocks through thick and thin. Figure 9 shows how equity and fixed income investor returns significantly lag those of the broad market indexes.
While there’s no question investors can earn near-market returns, many investors still erode their long-term wealth by shifting between assets or asset classes at inopportune moments. This not only reduces portfolio performance but can also derail progress toward personal financial goals and can cause tax issues. Maintaining a long-term perspective and avoiding emotionally driven decisions is essential for investing success.
Risks Are Real But Manageable
Discipline, not market timing, is the antidote to emotion. Patience and perspective turn volatility into opportunity.
We won’t sugarcoat it. Investing involves risk. Stock prices can and do fall, sometimes sharply. Bear Markets, defined as declines of 20% or more from a prior peak, along with geopolitical shocks and periods of market turbulence, are an inevitable part of the investing experience. Yet we have long maintained that risk is not a reason to avoid equities or investing altogether.
In the 56th edition of The Prudent Speculator on April 23, 1979, our founder Al Frank wrote, “We are in a tricky market atmosphere, with potentials for violent moves up or down. Because I sense that the main trend is upward for the long term, due to the historically low current valuations of most common stocks and massive funds awaiting market participation, I would rather be fully invested in selected equities for their probable price appreciations than avoiding the risks of a decline.”
The acceptance of volatility has been a recurring theme for five decades. We have worked diligently to be ready for rainy days, using market dips as opportunities to acquire what we believe are attractively priced stocks and building portfolios designed to help our readers and clients stay on track toward their long-term goals.
EQUITIES (TEMPORARILY) FALL
A great illustration of annual stock market gyrations is offered in Figure 11. Red dots mark the low point each year (peak to trough). Navy bars are the overall price return for that year. In no year did the S&P 500 index finish at its low point and full-year returns turned in an average price return above 9%, well above the average loss at some point during the year of 14%. “Buy the Dip” is market advice as old as time, but we have noticed that investors often are worried about catch falling knives versus picking up bargains.
Prices fluctuate, sometimes violently and especially in the short term. In Figure 12, the yellow boxes show years when the S&P 500 has had a decline of the magnitude on the vertical axis. A drop of 2.5% or more has occurred each year since 1928. Larger drops have occurred regularly, but somewhat less frequently, with years sometimes passing between 15% and 20% drops.
BROAD MARKET RISKS
Since our first issue, we’ve endured eight official Bear Markets plus countless shocks, including wars, recessions and other scary events, many of which are in Figure 13. Yet stocks have still managed to advance at a nearly 12% annual clip.
Black Monday struck on October 19, 1987, when the Dow plunged 22.6% in a single day, the largest drop in U.S. history. Panic, program trading and overvaluation fears fueled the crash, but losses were recovered by the end of 1988.
The Dot-Com Bubble peaked in the late 1990s, then burst in early 2000 as tech valuations collapsed. The NASDAQ fell nearly 80%, the S&P 500 dropped 37% and many startups vanished. A Bear Market followed, but the S&P 500 nearly doubled between the bottom and 2007.
The Great Recession, triggered by the housing bust and mortgage-backed security failures, caused the worst downturn since the Depression. Markets bottomed in March 2009, launching an almost 11-year Bull Market that returned a whopping 401% before dividends.
The COVID-19 crash in early 2020 saw the S&P 500 fall over 30% in 6 weeks before rebounding amid massive stimuli. By August, losses were erased, and stocks gained 114% from the trough.
History’s verdict is clear: market turbulence is inevitable, but staying invested through it remains one of the most important keys to long-term success.
Many of the market’s strongest days occur close to its worst. Investors who sell during downturns risk missing the early stages of a rebound, often when returns are the highest. Figure 14 shows that missing the five best days would have reduced an investor’s annualized return by an average of 14% over the last decade. Because these turning points are impossible to predict, maintaining consistent exposure is critical.
COMPANY-SPECIFIC RISKS
Even in the midst of what feels like roaring Bull Markets, not every stock is along for the ride. Individual companies can stumble for many reasons: management missteps, a product launch that falls flat, excessive borrowing that becomes a burden when rates rise or simply falling out of favor with customers and investors. Sometimes the cause is within the company’s control, sometimes it is not. Either way, setbacks happen.
That is why we have always championed diversification. Owning a mix of exposures helps ensure that when one name hits a rough patch, others in the portfolio can pick up the slack. It is not about eliminating risk, as no strategy can do that. It is about making sure that no single holding has the power to derail your financial plans.
It is also worth remembering that while the broad market has historically trended higher over the decades, day-to-day results can be surprisingly balanced. As Figure 15 shows, on an average trading day the number of stocks moving higher is about the same as the number moving lower. That might sound counterintuitive in a market that rises over time, but it is a reminder that “the stock market” is really a collection of individual companies.
This is why we evaluate each stock on its own merits, including earnings power, balance sheet strength, growth prospects, business quality and fundamental valuation metrics. We also consider how a specific stock works with the rest of the investment portfolio. Of course we want stocks that appreciate, but our parallel aim is to build portfolios that can pull their weight in all stock market environments, keeping us steadily on course toward our long-term financial goals.
Investment Strategies
Through decades of market storms and triumphs, TPS has championed patience, discipline and the power of compounding as the surest path to long-term wealth.
There is no single “right” way to invest, although some strategies have proven more resilient over time. Your personal investment strategy should reflect your objectives, risk tolerance, time horizon and temperament. It should be grounded in sound principles you can adhere to through thick and thin, rather than built around chasing trends, recent performance or watching financial television figures. Markets will ebb and flow, sometimes violently, and only a plan you believe in (and can stick with during turbulent periods) will allow the power of compounding to work to your advantage.
BUY AND HOLD
This approach is built on owning stocks for long periods, reinvesting dividends and ignoring short-term noise. The goal is to let compounding work its magic over time. The downside is that portfolio exposures can drift, and you may need to periodically manage risks that stem from concentration. In Figure 16, we illustrate a hypothetical lottery winner (nicknamed ‘LW’) who invested $1 million twenty years ago with no allocation changes over time. Half was invested in a stock fund (SPY) and half in a bond fund (AGG). At the end of June, the portfolio was worth $3.7 million.
DOLLAR-COST AVERAGING
This strategy invests a fixed amount on a regular schedule, irrespective of market conditions. The goal is to remove temptations to time the market and smooth out entry prices over time by systematically investing sidelined cash in the blended portfolio. In Figure 17, LW invested $1 million of lottery winnings on a monthly basis over 10 years instead of all at once. Twenty years later, the portfolio was worth $3.8 million.
BUY THE DIP
Perhaps LW won at an “inopportune” time. In 2005, the S&P 500 had bounced from the Tech Bubble lows and they felt the market rose too much too fast. In Figure 18, LW follows a ‘Buy the Dip’ strategy, waiting for a 10% decline and investing $100,000 after crossing that threshold. Despite the first few years passing without any investments (the first opportunity came in 2008), the portfolio still ended with $3.8 million.
A NOTE ABOUT THE HYPOTHETICALS
While each of the aforementioned approaches resulted in a similar ending value in our example, the path to get there looked very different. Buy and Hold delivered mostly steady compounding over two decades but required discipline to not get scared out of stocks during sharp drawdowns, most notably in 2008. Dollar-Cost Averaging reduced the impact of poor initial timing by spreading purchases over the first ten years, which helped smooth the ride and made it easier to stay invested. Buy the Dip deployed capital only after market setbacks, leaving money on the sidelines during some long advances but taking advantage of volatility when it eventually arrived.
It is important to recognize that these results are also highly sensitive to the dates we chose. Starting in a different year or running the test over a different period could meaningfully change the rankings or dollar outcomes. Market environments are never identical, so while the strategies here illustrate distinct philosophies, they are not meant to be prescriptions. The right approach depends on the investor’s ability to stick with the plan through whatever market environment the future delivers.
VALUE INVESTING
The Prudent Speculator’s long-held Value strategy shares important traits with the other three approaches while adding its own distinctive edge. Like Buy and Hold, it is built on the foundation of long-term ownership and the power of compounding, but it focuses specifically on companies trading at attractive valuations relative to fundamentals such as earnings, cash flow and book value. As with Dollar-Cost Averaging, fresh capital is deployed regularly, which helps take advantage of market fluctuations and reduces the risk of investing a large sum at an inopportune moment. And like Buy the Dip, Value investing is opportunistic by nature and leans into periods of market weakness to accumulate shares when pessimism is high and prices are more favorable.
What sets our Value investing apart is that it systematically applies these principles year after year, not just at inception or after large market moves. Rather than simply holding a static allocation or waiting for a predefined decline, it continuously seeks out individual stocks that are priced below their long-term worth, even when broader market valuations are stretched.
This disciplined process means that, over time, the portfolio benefits from the natural tendency of undervalued securities to revert toward fair value, while still harnessing the same compounding engine that underlies the other strategies.
PORTFOLIO CONSTRUCTION
Building a portfolio starts with defining your objectives, time horizon and comfort with risk. Decide what you want your wealth to accomplish (growth, income, preservation of capital or a combination) and how long you plan to leave it invested. From there, determine your target asset allocation (the mix of stocks, bonds, cash and other assets) that offers a reasonable balance of potential return and acceptable risk.
A capital appreciation-oriented investor with decades until retirement might lean heavily toward equities, while someone nearing retirement may favor a larger bond allocation for stability. Within equities, include a blend of company sizes, investment styles (Value and Growth) and geographies (U.S. and International) to spread risk and capture opportunities across different parts of the market. Once the high-level mix is set, choose investment vehicles that fit your personal asset allocation.
The aim is to create a diversified structure you can stick with through market ups and downs, allowing compounding to work to your long-term benefit and maintaining sufficient liquidity to meet nearer-term needs.
THROUGH THICK AND THIN
We think it’s important to call out that equity investing is not about outsmarting the market, it’s about outlasting it. The winners are rarely those who trade the fastest or guess the next headline correctly. They are the ones who select a sound strategy, commit to it through thick and thin, and resist the emotional swings that derail so many others.
Patience is the investor’s greatest advantage. The compounding effect that turns small sums into substantial wealth needs time to work, and it can’t do that if capital is constantly being pulled in and out of the market. Trying to sidestep short-term volatility often means missing the powerful rebound days that account for a large share of long-term returns.
Our goal is not to time the market, but to benefit from time in the market. That means accepting that downturns will happen, knowing that they have always been temporary and keeping focus on the bigger picture. With discipline, diversification and a clear plan, the market’s natural tendency to grow over time becomes a powerful ally.
STAYING THE COURSE
The history of the equity markets is a chronicle of setbacks overcome, and rewards earned by those willing to endure them. From our first issue in 1977 through recessions, panics, wars, disease, bubbles and booms, the lesson has been consistent: time in the market, coupled with a disciplined approach, is the most reliable path to long-term wealth creation. Stocks are not lottery tickets or fleeting trades. They are ownership in real businesses that grow, innovate and adapt.
No strategy can eliminate the bumps along the way, but a well-constructed portfolio, with reasonable valuation metrics and diversified across styles, sizes and geographies, can weather the inevitable storms. By focusing on fundamentals rather than headlines, by treating volatility as an ally rather than an enemy and by giving the magic of compounding the years it requires, investors position themselves to achieve their personal financial goals.
Staying the course is not simply a slogan. It is the essence of successful investing.
