If you’ve got serious doubts about investing in the stock market because you think you’ll lose your hard-earned money, then keep on reading.
First, let’s say that the stock market is represented by the Standard & Poor’s 500 Index, which is a widely recognized benchmark that tracks the stock performance of 500 leading companies in the U.S.
And, in order to achieve the performance of this index, let’s also suppose that you invest in the Vanguard 500 Index Fund Investor Shares (ticker symbol “VFINX”), which seeks to match the returns of the index as closely as possible.
In that case, this table shows the complete historical record of the fund’s annual returns.
Now, first of all, as the table shows, the one-year-at-a-time rates of return are all over the map. There are both large and small gains as well as large and small losses, and they all occur in what appears to be a random pattern. The table below summarizes the results.
1-Year Periods
| Average annual return | 11.45% |
| Best year | 37.45% |
| Worst year | -37.02% |
| Years with gains | 39 (81%) |
| Years with losses | 9 (19%) |
As you can see, at best, you earned 37 percent in a year, and at worst you also lost 37 percent. And because of this, it doesn’t seem very helpful to summarize these wildly different one-year results into a neat and tidy “average” rate of return of 11 percent, does it?
But, if you begin to extend the time horizon and look at the returns over five-year periods, then the numbers start to make a bit more sense. Check out the table below.
5-Year Periods
| Average annual return | 11.59% |
| Best 5-year period | 28.50% |
| Worst 5-year period | -2.38% |
| 5-year periods with gains | 39 (89%) |
| 5-year periods with losses | 5 (11%) |
Here, we see that there are fewer periods with losses, and the periods where you make money appear more often compared to the periods with losses.
“Why did this happen?” you wonder. Well, the reason is because as you increase the measurement period, the average annual rate of return begins to overpower the single-year differences.
So, what we begin to uncover from these first two examples is that the length of time that you hold on and stay invested in the stock market is an extremely important factor that determines both if and how much money you make. In fact, the remaining examples will reinforce this idea.
Now, if we continue to extend the time horizon and move on to 10-year periods, the numbers are also a bit more dependable.
10-Year Periods
| Average annual return | 11.30% |
| Best 10-year period | 19.04% |
| Worst 10-year period | -1.46% |
| 10-year periods with gains | 37 (95%) |
| 10-year periods with losses | 2 (5%) |
Once again, there are fewer periods where you lose money, and the periods with gains appear more often compared to the periods with losses.
Next, as we shift over to 15-year periods, there’s even more consistency in the results you experience.
15-Year Periods
| Average annual return | 10.88% |
| Best 15-year period | 18.68% |
| Worst 15-year period | 4.13% |
| 15-year periods with gains | 34 (100%) |
| 15-year periods with losses | 0 (0%) |
As you can see, there are no periods where you lost money. So, the sting of losing money is finally eliminated after 15 years. Or, to put it another way, in every period you made money, and what’s even more exciting is that the range of returns begin to stick much closer to the average annual rate of return.
And to highlight this phenomenon even further, the tables below summarize the stock market results for the 20-year periods through the 45-year periods.
20-Year Periods
| Average annual return | 10.63% |
| Best 20-year period | 17.56% |
| Worst 20-year period | 5.51% |
| 20-year periods with gains | 29 (100%) |
| 20-year periods with losses | 0 (0%) |
25-Year Periods
| Average annual return | 10.32% |
| Best 25-year period | 13.56% |
| Worst 25-year period | 7.44% |
| 25-year periods with gains | 24 (100%) |
| 25-year periods with losses | 0 (0%) |
30-Year Periods
| Average annual return | 10.66% |
| Best 30-year period | 12.68% |
| Worst 30-year period | 9.53% |
| 30-year periods with gains | 19 (100%) |
| 30-year periods with losses | 0 (0%) |
35-Year Periods
| Average annual return | 10.95% |
| Best 35-year period | 11.73% |
| Worst 35-year period | 10.30% |
| 35-year periods with gains | 14 (100%) |
| 35-year periods with losses | 0 (0%) |
40-Year Periods
| Average annual return | 11.40% |
| Best 40-year period | 12.14% |
| Worst 40-year period | 10.82% |
| 40-year periods with gains | 9 (100%) |
| 40-year periods with losses | 0 (0%) |
45-Year Periods
| Average annual return | 11.66% |
| Best 45-year period | 11.90% |
| Worst 45-year period | 11.33% |
| 45-year periods with gains | 4 (100%) |
| 45-year periods with losses | 0 (0%) |
Now, as you can see from the best and worst periods in each table, even though there are some pretty significant differences in the range of realized returns in each of the 10 different time periods, the average annual return is pretty consistent in all cases–between 10 to 11 percent. And the reason for this is because the returns are all calculated from the same original set of numbers.
Again, what we learn from these examples is that if your time horizon is short, the stock market does not look very desirable, and you’ll want to avoid it. But if your time period is long enough, you can invest in the stock market that seems risky in the short run, and you can do so without the fear of losing your money.
Now, you may be wondering, “Is it really reasonable to expect me to wait 15 years or more before making money in the stock market?”
Well, if that’s what you’re thinking, then it may not be a good idea to underestimate your investing time horizon. For instance, if you start making regular deposits to a retirement plan at age 25, and then, in retirement, begin to draw on the money you’ve accumulated until age 70 and beyond, you’d have an investment lifetime of 45 years or even more.
Once again, as long as you’re committed to holding on to your investments for a very long time, you’ve automatically insured yourself against the pain of short-term price swings. In other words, if you can earn substantial long-term returns, then in the grand scheme of things, does it really matter if you’ve lost and regained about 40 percent of your investments along the way?
And, since inflation has been a significant part of our history, isn’t the real risk that you face in the long run the risk of seeing the purchasing power of your money erode as a result of being too cautious?
So, the bottom line is that the solution to the problem of short-term risk is to become a long-term investor. That way, you can simply ignore the temporary instability in stock prices, and instead put yourself on the tried-and-true path to becoming wealthy–all while sleeping better at night.