Many people believe the stock market is risky. It’s often described as a casino, using words like crash, falling, and my favorite Wall Street word: “correction” meaning falling 10 percent or more from a previous high price. My definition of a correction is a temporary decline, which is then followed and surpassed by a permanent advance.
I help people to understand that risk is a permanent loss, or (more likely) the permanent loss of your purchasing power. In reality, money has never been lost when invested in a broadly diversified portfolio held long-term. You can easily lose money investing in stocks, but capital is not lost by an investor who is willing to hold a well-diversified portfolio of quality equities through their normal, sometimes frequent, short-term declines.
So why is it that our society seems to hold the belief that stocks are fraught with risk – a clear and present danger – when history does not show an example of this? The historical evidence is on the other side. Could it be the contrary financial messaging you hear? Could it be selling fear has a more significant impact than selling discipline?
I think the fear is inherited. The terror of a stock market crash capable of wiping out a lifetime of savings is so ingrained that it brings back generational stories of the Great Depression in the 1930s. The Depression was indeed tragic leaving generational scars. Retirees fear to invest in the ownership of companies in the form of stocks because they can crash. No wonder less than 50 percent of our population has any investments in stocks.
Over the lifetime of an individual, it is not uncommon for stocks to increase in value upwards of 100 times since birth. I was born 62 years ago in 1956. The S&P 500 equivalent was at 44.43, and today it is approximately 2,700. That is 61 times higher in 62 years. The scenario is even more stunning today for a 65-year-old born who was born on January 1, 1953. At that time, the S&P 500 was at 26.18 – versus 2,700 today – more than 100 times higher (same source). To find out where the market was when you were born, search online for “S&P 500 historic prices by month.”
When you consider a typical retirement time frame, say 30 to 40 years, living costs could more than double for a retiree due to inflation. The real risk is running out of income. The rising tide of dividend income from high-quality companies can more than offset inflation over a three or four-decade time horizon. The myth, however, is that stocks are “too risky.” My question: “Where did you get that idea?”
Good investor behavior means paying less attention to the value of your investments and more attention to the income or dividends. Since 1960, the cash dividend of the S&P 500 has increased at a compound rate of 5.76 percent versus about 3 percent for inflation or the CPI. People shouldn’t spend their principal; they should spend the income from their principal. So why is there such an emphasis on the daily fluctuation of principal?
Could it be a belief that Blue Chip companies are like casino chips? In reality, ownership in American companies represents the direct ownership in the earnings, cash flow, dividends and net assets of the very businesses you frequent each day. Ownership can be in the form of your 401(k), mutual funds, ETF products or direct ownership in the actual shares of companies. Prices fluctuate on the stock market, but long-term values are driven by real earnings and real dividends, yet most people see stock prices as random and inherently unstable.
When you own shares of a company, you are an owner of that company. Good investor behavior means acting like an owner, not playing gin rummy. Rather than becoming fearful as a result of negative financial messages, look around and pay attention to companies that provide goods and services to you and your family. Owners of successful businesses typically win.
All performance referenced is historical and is no guarantee of future results. Indexes are unmanaged and cannot be invested into directly.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
Hindsight is 20/20, but finding clarity in future uncertainty can be fuzzy. AT LPL RESEARCH, as we look forward to the year 2020 and a new decade, some key trends and market signals will be important to watch, including progress on U.S.-China trade discussions, an encouraging outlook from corporate America, and continued strength in consumer […]