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Gaining from financial destruction By Morgan Housel
"Market Rewarded Those Who Stuck It Out," it read.
You don't say.
The only thing worse than suffering through a period like the last five years is suffering and not learning anything from it. To me, there are three imperative investment lessons from the last five years. That "markets reward those who stick it out" is one of them.
For those who stuck out the last five years, the 2008 crash -- literally one of the sharpest wealth destroyers in history -- is now a set of painful memories at worst, and a once-in-a-lifetime opportunity at best. If you did nothing, your portfolio is likely larger today than it was in 2007. If you bought steadily over the last five years, it's probably much larger. Only if you sold near the bottom and hid somewhere else have you lost money.
Every weekday JewishWorldReview.com publishes what many in the media and Washington consider "must-reading". HUNDREDS of columnists and cartoonists regularly appear. Sign up for the daily update. It's free. Just click here. History is clear on this: Hold stocks for a long time, and your odds of making money are very high. Since 1871, there have been only four periods when an investor purchasing stocks didn't make money in real (inflation-adjusted) terms over a 10-year period: 1908, 1929, the late 1960s and the late 1990s.
If you purchased stocks once a month, every month, since 1871, 87.8 percent of your purchases would be profitable 10 years out, even adjusted for inflation. The four brief periods that left you in the red after a decade were invariably followed by above-average returns. Stocks rose despite the aftermath of a civil war, two world wars, a flu pandemic, terrorist attacks, droughts, presidential assassinations, depressions, recessions, crippling debts, bank runs, high inflation, deflation, oil embargoes and a dozen bubbles. Through it all, the market rewarded those who stuck it out. It is the same story time and again. It was no different this time, and it will likely be no different next time.
What else did we learn from the last five years? One of my favorite quotes from investor Jeff Gundlach is, "In risk assets, you make 80 percent of your money 20 percent of the time."
During the 21,000 or so trading days between 1928 and today, the Dow Jones went from 240 to 14,000, or an average annual return of 5 percent (not including dividends). If you missed just 20 of the best days during that period, annual returns fall to 2.6 percent -- which is to say, half of the compounded gains took place on 0.09 percent of days. That's the numerical version of Gundlach's wisdom.
Sure, if you missed the 20 worst trading days, you would have done much better. But most of the 20 best trading days and the 20 worst trading days happen during the same periods, often in the same months. No one can time the market so perfectly as to jump in and out on the exact right days. So what happens is that those who try to avoid the market's big drops tend to miss the market's even bigger gains. Those who sold when the Dow was at 8,000 may have thought they were smart when it continued to fall to 6,000. But then, before they knew it, it was back above 10,000, 12,000, 13,000, 14,000 ... and their attempt to time the market ended up costing them serious money. If you want to consistently enjoy the market's big gains, you have to put up with its declines from time to time. Trying to avoid that reality is one of the surest ways to earn poor returns. This, too, is the same story over and over again.
The third lesson from the last five years is that the single most important question an investor can ever ask is, "How long am I investing for?"
If you're a day trader, a down day is a loss. If you're five years from retirement, a down year can be scary. If you're in your 20s and saving for retirement, a down decade means little. The same outcome during a given period of time can mean very different things for different people.
My view is that money you'll need to access within five years shouldn't be in the stock market at all, and money you won't need for at least a decade should not only be in stocks, but invested with the view that at some point it will almost certainly lose half its value (temporarily). Volatility is part of the deal. It's perfectly normal.
If you know you're investing for the long haul, these ups and downs -- even a severe crash like 2008 -- take on a whole new meaning. I think a lot of why so many investors cashed out and hid on the sidelines over the last five years is that they never even asked themselves how long they were investing for. A young worker with three decades before retirement saw markets falling, and his first instinct was, "Get out, now!" when it realistically should have been: "Look, never before in history has an investor lost money in stocks on a 30-year basis. And stocks are cheap right now. Even if they go down much further, it doesn't make sense to sell."
On the other side, near-retirees found themselves caught off guard when money they needed now suddenly lost half its value. So asking yourself how long you have to invest goes both ways. What's important is that there is never a blanket definition of whether you should buy stocks right now. Who you are and how long you have to invest can create two different rational answers at the same time.
Someday, this will all happen again. More recessions, more crashes. And when it's all over, the same headline -- "Stocks Reward Those Who Stuck It Out" -- will be published yet again.
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Morgan Housel, a columnist at The Motley Fool, is a two-time winner, Best in Business award, Society of American Business Editors and Writers and Best in Business 2012, Columbia Journalism Review.
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