The stock market has gone absolutely crazy. I have had many people ask me over the last week or so if I am going to get out of the stock market. The answer is definitely no! Unless someone knows of a better way to build wealth long term, then I plan on staying in.
One of the statements I have heard too often lately is “I’ve lost all of my money in the market” or “I would have been better off burying my money in my backyard”. Basically, the feeling for many is that they should have never put money in the stock market. I would like to do some quick math and explain why I still believe it is the best long term strategy to building wealth.
Let’s take a look at a young, married 25 year old couple. I generally teach young couples to start saving for retirement as soon as they can in order to make compound interest work for them. The key is to be slow, steady and consistent. Let’s pretend this couple took my advice 40 years ago, they’re now 65, and went through the recent stock market decline. They had put $250 per month in mutual funds in the stock market for the last 40 years.
I will use the average rate of return for two of my mutual funds I own over the lifetime of the fund (roughly 12% at the end of July 2011.) This couple would have had 2.9 million dollars at the end of July, dropping to 2.7 million with the market decline over the last week or so. That’s right: 2.7 million dollars! If instead, they had buried the $250 per month in the backyard, they would have $120,000. That is a 2.6 million dollar difference!
To summarize, let us think about this for a minute. Would you rather have had 2.9 million dollars 2 weeks ago and lost $200,000 of it due to the market crash? Or would you rather have “played it safe” and not lost a penny of your $120,000?
My overall point here is to not buy the hype of losing all of your money if you are in the stock market. You may argue that I am using numbers over 40 years, which allows compound interest to work, so it is not fair. But that is exactly the point: the stock market is a long-term investment. It’s not something you use for a three year saving plan. Remember, slow and steady wins the race. If you keep that as your focus, you don’t have to stress out over what your investments are doing from day to day.
Matt’s note: If you’re very serious about an alternative investment you may want to consider investing in peer-to-peer loans as a way to diversify.
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At some valuations, the so-called long term may be long indeed. Most people have investment horizons of 30-40 years only. That’s not a long time. By assuming historical returns, you’re assuming that the next 30 years is going to be a repeat of the last 30 years. That’s not very likely. Given that the US is now in a Japan-like conditions, I suspect a higher return may be earned from a combination of gold (to cover inflation) and long term bonds (or consumer staples/utilities if you must be in equity) (to cover deflation). The stock market will be going nowhere or down.
Thanks for the comment. First of all, 30-40 years IS rather long. I’m not assuming the next 30 will be like the last 30, I’m assuming it will be like the last 70. That’s included going through many terrible and great times. To say with certainty that the stock market will be going nowhere or down over the next 30 years is quite a stretch. That will most likely be the case short term, but to assume that gold will continue to be a good investment when it’s at a record high right now doesn’t make much sense either. If our entire goal over the next 30-40 years is to just cover inflation, then no one is going to be able to retire. I just don’t know of any other place, where there is historical perspective, that will have a potential to produce the gains stocks have. I don’t sell any of this stuff, so I have no dog in the fight. I am just taking an educated risk that stocks will recover just like they always have. But, you do make a great point, that all of it is a risk: there are no guarantees. Thanks again for your input.
From 1905 to 1942 US market returns were zero. That’s 37 years of going nowhere. Compared to that, 30-40 years is NOT long. If you have such an interval of zero returns, it will impossible to recover from it because you can’t invest for 70 years unless you plan to keep working until age 100.
Also, if you take out the large drop in interest rates which have been driving equity from 1983 onwards, that is, only consider historical returns up to 1983, stocks don’t look so hot “in the long term” anymore. This is important, because interest rates can’t go much lower than they already are. Hence there’s no similar drive left.
Compared to stocks (not devalued cash), gold is still 40% undervalued and not at a historical high.
Are you suggesting to put all retirement investing into gold? It appears so, which goes against any expert I know of. Smart Money Magazine still suggests being heavily invested in stocks if you are a young couple. They also just put up an article suggesting 2% of your portfolio into gold is sufficient, with 5% being “gutsy”. Kiplinger’s also suggests that stocks are still a good option: see http://bit.ly/nYjvTk and http://bit.ly/r4e9N5. I’m just curious, do you sell gold or something? I’ve yet to hear or read anyone with any credibility suggest that people (even close to retirement, not to mention decades before) get out of the stock market. Just not sure where you’re coming from here.
The craziness of the stock market over the last few years has allowed us to build up a solid portfolio that we may not have been able to afford this early in life without the big dips. So no, I wouldn’t get out of the market right now. If anything, this is where you buy low to sell higher later, right?
I hear ya Crystal!
It is just time to buy, not sell. Some stocks have been attracting me.
Thanks for the input harry! Definitely time to buy.
People suggesting a 30 year time frame is not “long” are crazy. The biggest risk you can take is not taking enough, have a balanced portfolio of dividend stocks, bonds, and other short term investments and you will come out on top in the end.
Thanks Evan!
Hi Mike. I agree with you that the stock market is the place to invest your savings when you take a long-term perspective. I only do not agree with the buy-and-hold approach when there are much better alternatives. There was no reason to leave your savings in the stock market between 2001 and 2003 and during 2008.
These were long bear markets that you could have escaped from when following some simple long-term trend signals for stock market indices. Yes, I lost 40% of my savings in 2001 and it will try to avoid that this happens again to me. Not by avoid the stock market, but by stepping out in time. I sold for example most of my holding on August 1 2011 and the rest now in the beginning of September. Time will tell if that was a profitable decision, but I think it was.
Thanks Van Beek. I appreciate your input. And I agree that, ideally, you are going to sell high and buy low. If we could all predict exactly when those high and low times are, then we definitely would all be richer. I just don’t have the knowledge or time to figure that out, so I am completely comfortable with an AVERAGE return of around 12%. I think that should do me just fine. I definitely know people who use your strategy and do well. Unfortunately, most people try it and miss the high or miss the low and when it’s all said and done come out about the same if they would have just left it alone. Thanks for the input.