This is one of the most common answers I get, whenever I suggest to someone that they should invest in the market, "the Stock Market is too volatile. I'm gonna wait for things to settle down."
At social gatherings I often hear the older generation of aunts and uncles recommend the younger generation to get out of the market.
"Don't invest in the stock market, you'll lose all your money!!"
Often times, the older generation is speaking from their own experience and they're not completely wrong. You CAN lose everything if you don't know what you're doing.
If you're a full time doctor, or accountant, or plumber, etc. and are trying to beat the market or "time" the market, or trying to find the next Facebook stock to put all your money in, yeah, you're probably going to lose. Remember, we're not here to speculate. We're not here to predict the future so that we can make a quick buck in a couple of years. This isn't a Wolf of Wall Street mentality with fast action, cocaine and hookers, my friend *insert McConaughey Chest thumping* You want action, go to Vegas. We're here for the long haul.
Now, when people tell me that they are going to wait for the stock market to settle down in order to invest money, they're playing the wrong game and have the wrong mentality. First and foremost, the stock market is always volatile! It's almost always going up and down and very rarely settles. Waiting for the stock market to settle down is not a winnable strategy, unless again you're trying to time the market, which we're not as passive investors.
Although volatility is very real, palpable and stressful for any investor, it is VITAL to understand what drives long-term stock market growth. Once we uncover this mystery, we can invest with more confidence.
The graph below (Taken from Jack Bogle's amazing book, "The Little Book of Common Sense Investing.") shows us the growth of $1 invested in the market from 1900 to 2010.
Now before you start freaking out, I want you to rest assured that this will be a piece of cake to understand. I will do my best to walk you through every step of the way and explain every part of the table. No need to get overwhelmed, just follow my lead.
So, as you can see from exhibit 1.1 to the left, the bottom row of numbers (x-axis) denotes the time period we're looking at. We're looking at a time period of 110 years from 1900-2010. The left hand row of numbers (Y-axis), exhibit 1.2 below, is merely the growth (in dollars) of the stock market.
Now, we've got to talk about the lines on the graph. The solid line is the growth (in dollars) of our personal investment ($1) over the 110 year period. The dotted line shows the growth (in dollars) of the stock market over the same 110 year period. If you're wondering where and how I'm getting that info just look at exhibit 1.3 below:
Simple, right? Now, lets look at the good stuff. As we track the lines over this 110 year period, we see that there are ups and downs in the short run (ex. 1910's-1920's, 1930's, 2008), but overall from start to beginning the overall growth of our dollar and the market as a whole is upwards. In fact, when you average all the ups and downs of the journey, the Average Annual Growth Rate of the stock market was 9.5% and the Average Annual Growth Rate of our dollar was 9% (exhibit 1.3). The two growth rates were almost the same! (The discrepancy may be due to speculative growth. I'll get into that soon)
"What's the point?" you may be asking yourself. "Why does this matter?" Well, there are a couple important conclusions to draw from this graph:
First, this 110 year period for the American Economy is one of most tumultuous times in our history. In this 110 year period we went through four major hits to our stock market and country as a whole--The Great Depression (1920's-30's), the Oil Crisis (1970's), the Dot Com Crash (1990's), and the financial crisis (2008). Despite that, the average rate of return of the stock market in this 110 year period was 9.5%, which would have turned our $1 investment in 1900 to about $39,000 in 2010! (Of course the Mainstreet investor would be dollar-cost averaging the whole time, so the total amount returned would have been much much higher)
Second, it is important to see that the long term-trend of the stock market is upward. In the short term, yes it is very volatile. If you had to live day in and day out of this 110 year period you have gone through four very tumultuous setbacks. Despite the short-term recessions and depression, our $1 investment would have grown by an average annual rate of 9%. As long as we kept our money in the market during the depression and recessions, we would have STILL come out ahead in the 110 year period. But we have to KEEP our money in the market. It would have been very tempting during the great depression to take our money out and join the frantic mob. Fear feeds on fear, but as you can see from this 110 year history, and even the entire 200+ history of our country, we bounce back. American Businesses are very resilient. That is something we need to trust into our future.
Now, as I have been saying in previous blog posts, I can't and won't promise you that in the next 110 years, America's stock market will average an annual rate of return of 9.5%. I can't tell you when the next recession or next depression will come, but I know it will. That's just life. There are highs and there are lows. Winter is coming (For all of my GOT fans out there). When winter comes the Whitewalkers will come out, trying to stick fear into our hearts and stab us with their blades trying to turn us into one of them. It will be tempting for us to run for the hills, but remember one very important thing: we've got Dragonglass and Dragons. We must stand our ground and not give into the fear. Instead, we must continue forward.
Wow, that got pretty dramatic, but the point remains the same. If you don't believe me then at least believe the investing legend himself, Jack Bogle: "The Message is clear: In the long run, stock returns depend almost entirely on the reality of the investment returns earned by our corporations. The perceptions of investors, reflected by the speculative returns, counts for little. It is economics that controls long-term equity returns; the impact of emotions, so dominant in the short term, dissolves."
Just to drive the point home some more--long term stock market growth is driven by the enterprise of our corporations. By enterprise, I mean that it is companies creating REAL goods and services, that create REAL profits, causing them to give out REAL dividends, leadership of companies implementing REAL plans and strategy for REAL growth and REAL innovation. The returns earned from noise and people's emotions (Speculative Growth) have very little to do with long term growth. (In that 110 year period from the graph above, only .5% of the discrepancy between market growth and our investment growth was due to speculative growth. That's very little!!)
I feel like all this talk about speculative growth and real growth is a great metaphor for our lives and will help us understand even further what drives long-term stock market growth. Without getting too spiritual or philosophical, we can see these two concepts at play in our daily lives. On a daily basis we go through ups and downs. We put up with noise from the outside world--discouragement, encouragement, love, hate, support, fear, jubilation--but ultimately the only reason we accomplish anything is because we ourselves show up to do the work. Rain or shine we show up to the things that matter to us--our relationships, our diet, our yoga class, our career--and we make progress in these aspects of our lives because we do the real work. Even when the world is speaking ill of us and trying to discourage us from continuing, we show up. THAT'S why in five years, ten years, twenty years--whatever the time frame--we make progress. The outside noise has very little to do with our personal growth. It's US doing the work day in and day out. Its the same damn thing for economies, cities, countries, etc. These are not esoteric entities or organisms, they are in fact larger versions of humanity. And like us doing the REAL work day in and day out and getting REAL growth, so too the same applies to our countries' long-term stock market growth.
So what am I really asking you to invest in? I'm not asking you to pick the next Apple Inc. or Facebook, I'm asking you to invest in the whole damn country. I'm asking you whether or not you believe that America's businesses can keep up their resilient spirit and drive for innovation into the future. Again, I can't promise you anything for the future, but history shows us that for 200+ years we've been doing just that and I don't think it's very likely that will change anytime soon.
Now if you do believe that it will change for the worse then that's fine too. If you think America will go the way of the Roman Empire and the Dinosaurs and become extinct in the coming future then you can believe that. And if you do believe that, then from a purely pragmatic standpoint, you should not only take your money out of the American Economy, but move to another country that you think will exist in the future and then once you become a citizen of that country, invest in their stock market. Again, not trying to be a jerk here (Not trying to sell American Patriotism here. Not interested), but you should invest in the growth of your country not because you have to or it's patriotic to do so, but for the simple reason that you can. And by doing so, you will do a great deal of service for your long-term financial health.
How and what do I invest in? Well in the next blog I'll show you an interesting investing vehicle known as index funds to get your started.
So to wrap up, next time you're at a family function and the debate about the stock market comes up, tell your aunts and uncles what you learned from this blog post. Long-term stock market growth is driven by the enterprise of our corporations, not the emotional swings of the outside world. In the short-term (during the next depression or recession), yes, it will be scary to keep your money in the market while everyone else is running around in a panic, but you're invested in the resiliency of American businesses and if history has shown us anything, it's that American businesses bounce back.