Here is why almost everyone young and old should have at least some stocks in a portfolio. The long term returns of the stock market, with all its ups and downs, have almost always beaten inflation and taxes over 10, 15 and 20 years. However, within those long periods, have been periods short and long when the stock market was a horror show.
One such period was beginning around March of 2020 owing to the Coronavirus. Through the first few months of the year it was down by 20 percent. Then, just as many were dumping stocks, the stock market recovered and was up for the year about 15 percent. So what started out as a bearish year turned into a bullish one. The people who got out when things looked bleak, who locked in their losses, must have felt like fools.
They should have remembered that there is always the possibility that some unexpected event can temporarily waylaid your plans to achieve financial independence.
Stay Calm
This means that the MoneySense investor must be a person who is calm, analytical and, above all, patient. He or she agrees with an ancient philosopher who said that “he who has patience can have anything.”
So this kind of person believes that the surest, safest way to financial independence is achieved slowly. One becomes rich by each week or month putting money into good investments—ones with low costs and proven long-term records such as Vanguard S&P 500 Index Trust, among others—on a regular basis and having the right mix of investments.
The right mix is what is called asset allocation. For instance, say you invested solely in long-term government bonds over 85 years between 1926 and 2011, your rate of return was 5.7 percent a year. However, say you had a portfolio that was half stocks and bonds over the same period. Your rate of return was almost 50 percent better at 8.3 percent. That was a huge difference. The numbers are from Ibbotson Associates, a Morningstar Company at Ibbotson.com.
This right mix means a combination of stocks, bonds, some cash and possibly a little bit of alternative investments such as gold or real estate. (Alternative investments, such as gold and other metals, are the ones that tend to perform very differently than the stock market. Their performance has little or no correlation with the stock market. A little of them in a portfolio can be a good thing).
What’s the Formula?
The asset allocation formula can vary from person to person and can also vary based on a person’s age as well as goals. One follows this formula for years. Investing, as many people learned in the market meltdown of 2008, can be dangerous in the short term. That’s a lesson we were re-learning in 2020. That is why one is much more likely to do well by staying the course for long periods than by trying to make “an overnight killing” or by jumping in and jumping out of the stock market. This is based on the spurious idea that you can always pick market lows or highs. This is market timing. Most market sages call it moonshine.
But the disciplined, steady investment philosophy also means one must approach investing with realistic expectations. The stock market, based on historic returns, doesn’t provide 20 percent returns every year. Indeed, based on its long-term history, one year out of three, it tends to go down. However, its long-term return is about nine percent and change a year. That might not sound fabulous. And, in the short term, it isn’t.
Still, getting a little more than nine percent a year, say over 20 years, could be remarkable. It could build a fortune for almost anyone willing to sock away a few hundred dollars a month over a few decades. Say you put $500 a month, or $6,000 a year, into an investment that earns nine percent a year over twenty years. You’ve invested $120,000 over the period. What do you have, not deducting for taxes? You have $336,448.
And if you started ten years earlier and invested $180,000, you would have a bit more. You would have $922,237! Mon Dieu, shake a leg, will ya!
Overnight Geniuses Not Wanted
So the MoneySense investor doesn’t expect to make millions of dollars over night. He or she is patient; a long-term investor. That kind of make a fortune overnight person, the MoneySense person knows, is a sucker. And the “I might make a million” overnight investor is perpetually playing lotteries. He or she expects that someone is going to suddenly give him millions of dollars. He or she thinks the Publishers’ Clearinghouse people will be knocking at the door any day now.
Is it impossible for this person to get rich?
No, it’s not impossible. But it’s highly unlikely. The chances are so stacked against him or her that this person is unlikely to ever achieve financial independence. Remember, although one person does win the grand lottery prize, governments that run these Three Card Monte schemes never talk about the millions of people who play these games year after year and never win a substantial prize. By engaging in these self-destructive games of chance they are wasting the opportunity to achieve financial independence.
The Sensible Investor
The MoneySense person, with a long-term plan of consistent investing in good stocks, bonds and mutual funds, backed by sensible spending polices, is much more likely to accumulate a huge stash. And that ultimately ensures that the investor’s buying power—the ability to command goods and services that maintain his or her lifestyle over multiple decades—is protected. That means the value of his or her money was able to outpace taxes and inflation.
How important is that?
Very important.
Preserving a Standard of Living
Say you have $50,000 a year in income and that is just enough for you to live decently. What do you need to maintain the standard of living years from now? Let’s assume that the traditional inflation rate of the past half century or so in the United States continues in the future. What will you need in twenty years to match today’s $50,000? You‘ll need an income of $90,000 a year just to stay in place. You’ll need to increase your yearly income substantially. Successful investing is one way to do it.
That is why we are going through why and how to invest on a regular basis. Investing is something that has both risks and rewards. This chapter and succeeding ones examine strategies for maximizing the latter and reducing the former. The greater the risks one takes in investing, the greater the potential reward and, conversely, the greater the potential losses. It is important to understand both factors.
We’ll discuss them in our next installment.
