You might think that stocks are risky and people lose money in the market. In fact, stocks are the safest long-term investment. Surprised? Keep reading to know how.
If you haven’t read my previous post on the power of the stock market, I’d recommend starting there. It shows the power of stocks in the long run. In this article, I’d like to touch upon the journey of holding stocks.
From my previous post on the stock market, it is clear that investing in the stock market is the ultimate wealth-building tool. You might be thinking “If that’s the case, why is everyone else not investing in stocks?”. The journey involves lots of ups and downs. There is no free lunch. Let me explain.
Stocks are more volatile in the short term than any other asset class. To find out how risky/safe the stocks are, Jeremy Siegel, the author of “Stocks for the Long Run“, looked at the historical range of real returns (inflation-adjusted) for multiple holding periods for stocks, bonds, and bills. The time period is 1802-2012 (210 years).
The holding periods were 1, 5, 10, 15, 20, and 30 years. He looked at the best and worst returns in all the holding periods. As an example, for a 5-yr holding period, the author looked at the years 1802 – 1806, 1803 – 1807, 1804 – 1808, …………, 2007 – 2011, and 2008 – 2012. The worst and best returns for all these 206 holding periods are analyzed and displayed in a chart. Similar analysis was done for 10-yr, 15-yr, 20-yr, and 30-yr holding periods.
Here is a chart showing the historical range of real returns (inflation-adjusted) for multiple holding periods for stocks, bonds, and bills. The best and worst returns after inflation for stocks, bonds, and bills over multiple holding periods are displayed in the chart.
It can be clearly seen from the chart that over the short term, stocks are volatile. Over a year, you could expect a return anywhere from +70% to —40%. That is a big variation over a span of one year. For bonds, your return could be anywhere from +35% to -22%. For bills, the return could be from +24% to -16%.
But, here is the interesting part — as the holding period increases, the volatility for stocks keeps decreasing. For a 5-yr hold period, the worst return for stocks (-11.9%) is only slightly worse than the worst performance in bonds (-10.1%) or bills (-8.3%).
For a 10-yr holding period, the worst return for stocks (-4.1%) is actually better than that for bonds (-5.4%) or bills (-5.1%). This means if you buy and hold stocks, bonds, and bills for ten years, it could be possible that your stock returns could be higher than the bonds and bills. So, holding bonds and bills for the long-term may not be safe.
Over a 20-year holding period, no matter when you invested, stock return never fell below inflation. This means you would have never lost money in the stock market. Over a 20-year period, the real return (after inflation) could be anywhere from +1.0% to +12.6%. Isn’t that amazing? I think it is.
For the same holding period (20 years), the volatility for bonds and bills is +8.8% to -3.1% and +8.3 to -3.0%, respectively. This means that if you had bought bonds/bills and held them for a 20-yr period, there is a chance that you could lose money after inflation. You might think that -3.1% isn’t much, but, it can almost wipe out a portfolio in the long term.
My point is that stocks are more volatile in the short term but less volatile in the long run. Young people need to invest more money in stocks since they have a long time horizon.
Time is the most powerful force in compounding. If we can achieve consistent returns for a long period of time, compounding will go nuts.
There is no guarantee that you would expect the same returns as above. However, we must start by analyzing the past data to plan for the future.
“Although it might appear to be riskier to accumulate wealth in stocks rather than in bonds over long periods of time, for the preservation of purchasing power, precisely the opposite is true: the safest long-term investment has clearly been a diversified portfolio of stocks.”
— Jeremy Siegel
Jeremy Siegel said, “It is very significant that stocks, in contrast to bonds or bills, have never delivered a negative real return to investors over periods lasting 17 years or more.”
It is worth repeating — stocks have never given investors a negative real return over a 17-year horizon.
You might think that 17 years or more is a long time to hold stocks. I don’t think it is really long if you want to get rich slowly.
The average life expectancy is ~80 years in the US. A person who starts investing at age 25 and retires at 65 has 40 years of investing.
Even if you start at 45 and retire at 65, you have 20 years of investing. Remember that you won’t withdraw your entire portfolio at 65 and keep it in cash. So, even if you start at 45, you will still have 35 years of investing years.
“Most people overestimate what they can do in one year and underestimate what they can do in ten years.”
— Bill Gates
It is never too late to start investing in stocks. If you’re in your 20s and 30s and reading this article, you might be one of the luckiest because time is the most powerful force in investing. Compounding will go nuts if you give it enough time.
Key Takeaway:
Start investing now. Don’t wait. Your future self will thank you. Think long-term. Invest in stocks. Young people should put as much money as possible into it as early as possible. Set it and forget. Let the compounding do its magic!