“The masses are always wrong.” – Ayn Rand
Have you noticed that nearly every investor is investing defensively these days? Many investors have lost faith in the long term growth of the stock market. This is not surprising after the big crash in 2008. It has made investors more aware of risk.
It can be hard for investors to know what to do when they are not confident in the market. The bottom in the market was 20 months ago, but there is still a lot of bad news and fear about what may happen. Will we have another debt crisis? Will we have high inflation? Will unemployment stay high? Will the market crash again?
What happened in the past when we had pessimistic times like this?
Studying past markets is actually quite reassuring. It shows 3 solid reasons why investors should maintain confidence in the stock market:
1. Stock market growth is much more consistent over time than most investors realize.
2. Pessimistic times are usually the best times to invest.
3. Maintaining long term faith in the stock market is very rewarding.
Stock market growth is much more consistent over time than most investors realize.
Most people think that stock market ups and downs are completely erratic. In actual fact, stock markets have been quite consistent in rising throughout history when you stay invested for a period of time – and there are good reasons for it. Note the odds of making profit since 18711:
% Chance of Gain if invested for:
1 year 72%
7 years 96%
15 years 100%
Why are gains so consistent? The stock market is primarily driven by the profits of huge companies. Whatever happens in the economy or politics, companies are able to adjust their operations so that they can continue to increase their profits. They can cut costs, raise prices, develop new products or expand to new regions.
In addition, new companies with high profits are often created and join the stock market. For example, quite a few large, very profitable companies in technology such as Microsoft, Google, Research in Motion, Apple, eBay, Dell and Cisco were tiny or did not exist 20 years ago.
The stock market has been described as a see-saw moving up a hill. Over time, these huge companies are able to grow their profits. Short term, sentiment is erratic because much of it is based on human emotion. However, eventually logic and the fundamentals of rising profits will win and the market will rise. That is why the market consistently rises when you stay invested long enough.
Pessimistic times are generally the best times to invest.
In pessimistic times like this, the question is always asked: Is it different this time? Could the system collapse “this time” or could we have another decade of low growth “this time”?
This mantra has nearly always been wrong throughout history. “The 4 most dangerous words in investing are “This time it’s different.” (John Templeton)
In fact, the biggest gains usually follow the most pessimistic moments. Note the wisdom of John Templeton: “Buy at the point of maximum pessimism.” And Mark Mobius: “Buy when there is blood in the streets – even when that blood is your own.”
The wisdom of these quotes can be seen in this graph of 10-year rolling returns.1
Note first of all that there are hardly any decades without a gain. There is a more interesting and surprising conclusion, though. Note the low periods in the graph? Now look 10-15 years before and after each low period. Note that there are big, high peaks in the 10-year periods just before and just after the lows?
Here are the actual returns:
Before & After Worst 10-Year Periods
Period Return Prior 10 Years Return Next 10 Years Return
1881-90 2.6% 1871-80 10.0% 1891-1900 8.4%
1887-96 1.7% 1877-86 10.6% 1897-1906 12.9%
1911-20 3.5% 1901-10 7.5% 1921-30 14.2%
1929-38 -1.4% 1919-28 18.7% 1939-48 7.8%
1965-74 1.1% 1955-64 12.6% 1975-84 14.8%
1999-2008 -1.5% 1989-98 19.3% 2009-18 ?
There are always many reasons given for decades of high or low growth, but perhaps there is a much more simple reason – market returns are much more consistent than investors realize. Bad decades are usually preceded and followed by great decades (and vice versa), which just brings the non-normal returns back closer to normal.
In short, investors have been well-rewarded by maintaining faith in the stock market – especially during pessimistic times.
Maintaining long term faith in the stock market is very rewarding.
From our experience, we have noticed that investors that have faith in the stock markets long term tend to do very well, while those that are nervous of the market tend to buy and sell at all the wrong times. The most successful investors tend to be the ones that stay invested all the time.
If you stay invested for 20 years, even during the most pessimistic times, the returns have always been acceptable – and almost always very good. You would have made 5%/year or more 97% of the time. Here are the worst and best-case scenarios:
If you invest for 20 years, you will have1:
Worst case 3.1%/year Almost double your money
Average 9.3%/year 6 times your money
Best case 18.0%/year 27 times your money
Doubling your money over 20 years is not great, but if that is the worst-case scenario, but it is certainly nothing to be scared of!
Whenever the stock market returns are low, comparisons are made to other investments. Since the last 10 years have had no gain, investing in almost anything else would have been better.
What are investors doing now? Investors have a short term memory and tend to base their investment strategy on recent events. That is why the most popular investments now are cash, bonds, GICs, gold and real estate (in Canada), with stock market investments focusing on dividend stocks, market-timing strategies, or “anything with a yield”.
These are all the areas that performed better in the last 10 years and they are all defensive in nature. They are popular because of the fear created by 2008 and negative news.
However, how do these other investments compare long term? The surprising truth is in the chart below – the long term growth of other investments, such as G.I.C.’s, real estate or gold, is tiny compared to the stock market. Note that gold and real estate have not even kept up with G.I.C.’s!
The dollar values in this chart start with $64,559, which was the average price of a home in Toronto in 1977. At the end of 2009, the average home in Toronto was worth $411.931, but if you had invested the same amount in the Toronto Stock Exchange, you would have had $1,886,820. You could now buy almost 5 houses!
Investing and staying invested in the stock market is very rewarding.
It can be hard for investors to know what to do when they are not confident in the market. Market history shows why investors should maintain confidence in the stock market as the main investment vehicle for retirement planning and other long term goals. The stock market consistently rises when you stay invested long enough.
This is particularly true during periods of time like today when there are many reasons to be pessimistic. Investing during “maximum pessimism” and after bad decades have been the best times to invest.
Investors that have faith in the stock markets long term tend to be very well rewarded, while those that are nervous of the market tend to buy and sell at all the wrong times. The most successful investors tend to be the ones that stay invested all the time.
1 Standard & Poor’s – calendar returns 1871-2009
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