To many people, investing in the stock market seems a lot like gambling. You are putting up money today, hoping to grow it by buying stocks that will be more valuable in the future. The risk is that the companies you pick are less successful over time and thus your stock value doesn’t go up (or even goes down). At first glance this seems just like betting on horses at the track. Sure, there might be a favorite to win, but you’re not going to make as much money betting on the one expected to win. This analogy rightly scares many individuals away from viewing the market as a place where any sensible person would put their savings, and that is a good thing.
Fear is what keeps the stock market healthy, making sure that valuations don’t become too overinflated or underpriced. However, while being a mostly free and efficient system, it is by no means perfect. Fear can exit the marketplace for a period, only to return in full force (as has been shown in years like 1929, 1974, and 2009). Add in short-term market fluctuations in the intervening years and it’s easy to see why it’s such a scary asset class. Times like 2009 are the most obvious examples, but many eager investors have trouble navigating smaller market fluctuations. The S&P 500 (an aggregate fund of the largest 500 companies in the US) returned 2.11% in 2011[1], the year many regarded as the end of the last recession. A dollar invested in January of 2011 would be worth $1.03 over one year. In a year like 2011 where inflation was just over 3%[2], you have essentially made no return while taking on all the risk mentioned above.
Not only do investors have to worry about the risk of market fluctuations eating away returns, but there’s also the multitude of investment vehicles that can result in advisor fees, confusing annuities, and loaded hedge fund fees where a significant portion of invested capital goes straight into an advisor or managers pocket. These fees, charges, and sales commissions can also eat away at returns while building a natural distrust in the client/advisor relationship.
Real estate investments are less liquid and often considered easier to value while bonds provide a fixed rate of return that investors can count on (if held to maturity) based on a credit rating. So, given all this risk and uncertainty, why would any smart investor put hard earned money in the stock market?
The answer, put simply, is that the long-term rate of return in the US stock market is dependable. While the S&P 500 may be up, down, or flat during any one period, its annualized investment return over the past century levels out to about 10%[3]. That dollar invested back in 2011 is now worth a little over $1.50, a dollar invested in 2001 is now worth just over two dollars, and a dollar invested way back in 1991 is worth about $14.5 today (October of 2018)[4]. We believe these returns speak for themselves, over long periods of time we think American business is a pretty safe place to have your money. After all, the stock market is just a place to buy and sell pieces of businesses, nothing more complicated than that.
Great returns in the market don’t require a financial genius or extreme amount of luck. Most people can enjoy a reasonable return by investing in something they understand and staying invested for the long term. When investors are focused on a simple long-term strategy, the market fluctuations become a benefit. Long term investors can use these periods as buying opportunities, making other investors erratic behavior work to their advantage. For instance, every dollar invested in the S&P 500 in January of 2009, near the bottom of the last recession, would be worth over three dollars today (a better return than our theoretical investor who purchased in 2001!) simply by recognizing a time in which fear in the marketplace was evident. To make a long story short: while appearing risky in the short term, the stock market can be a powerful wealth building tool in the long run for a patient investor. The key is to invest for the long term and remember this piece of advice from the great Warren Buffett, “Be fearful when others are greedy and greedy when others are fearful”.
[1] S&P 500 Annual Return (Yearly) – https://ycharts.com/indicators/sandp_500_total_return_annual
[2]Consumer Price Index 1913- | Federal Reserve Bank of Minneapolis – https://www.minneapolisfed.org/community/financial-and-economic-education/cpi-calculator-information/consumer-price-index-and-inflation-rates-1913
[3] What is the Average Annual Return for the S&P 500 | Investopedia – https://www.investopedia.com/ask/answers/042415/what-average-annual-return-sp-500.asp
[4] S&P Return Calculator, With Dividend Reinvestment | DQYDJ – https://dqydj.com/sp-500-return-calculator/
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