The Market Works In Cycles
25 February 2017
Many investors or potential investors we meet assume that once they put their money to work, they are guaranteed a return. Unfortunately, that is not how investing works. You get a return on your capital for taking a risk on owning shares of companies, or lending them money to generate economic advantages.
The market, being liquid and traded daily with millions of shares changing hands and affecting the price, also gets affected by investor sentiment and the economic cycle. As the global economy goes into recession, as the world gets hit with political problems, war and conflicts, commodity problems, the stock market prices in these risks accordingly. The chart below shows how investing a dollar into global equities in the 1970s would have turned out – it grew by 45 times. This is despite the world undergoing various turmoil over the years, from the Oil Crisis to Black Monday, the Gulf War, Dotcom Bubble, 9/11, the Mortgage Bubble, and the European crisis. The market has suffered serious sell-offs but has always recovered and subsequently gone higher.
Source: Dimensional Fund Advisors
Analysing an even longer term chart on the stock market – in this instance, the US S&P 500 index, which has a long history – we can see that there have been many periods in the past where the market has gone sideways for many years. During these periods, it is very likely that investors would have gotten a 0% or even a negative return over 10-15 years! That is a very long time to leave money idle, with the most recent period being the 2000-2013 secular bear market.
Source: Ned Davis Research, Inc.
When you measure rolling periods, we can see that even when holding stocks for 10 years, despite a high probability of a positive return there is still a 3.7% chance that you would not make any money. It happened in the 1940’s and has just happened in the 2000’s. It is unfortunate that we had just lived through such a period. However, investors should be comforted that statistically, time is on their side if they stick to their gameplan and hold out for 20 or even 30 years – as the probability of a positive return for holding through such a long time is 100%.
It is very likely that investors during such painful times would have questioned whether the stock market had been broken and most likely would have lost faith and sold out at a loss. However, because the returns of the market are seemingly “random” with no one able to predict when there will be a strong upturn, it is much better to buy, and hold and only review your investments when your circumstances change. There is no benefit in checking the prices of securities every day, hour or minute and it will be better to relax without stress, with the knowledge and belief that markets have worked, and will still continue to work to your benefit.
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