I love the stock market. For all its flaws, and the angst we feel when it goes down, it is the most reliable long-term road to riches available to most of us.
No one needs an MBA to succeed. It can be as simple as this. Save some money, buy low-cost diversified index funds like the S&P 500, hold them, and repeat the process as often as you can, for as long as you can.
A lot of smart people make investing more complicated than what I just described. They can spend hours trying to time the market, or figuring out what stocks to buy. If they worked hard to succeed in their profession, they assume hard work in investing will also succeed. But in spite of their hard work, most are destined to fall short of market averages.
Even the professional money managers seldom beat this simple method of investing. 2020 was the 11th straight year the majority of money managers failed to beat the market averages. Investing is one place it’s smart to strive to be average.
Want more proof? Warren Buffett famously won a $1 million bet and humiliated investment manager Ted Seides. He bet that a low-cost S&P 500 index fund could beat a hand-selected hedge fund portfolio managed by ultra-smart money managers over 10 years. The low-cost S&P 500 index fund cleaned their clock earning 7.1% annually compared to the paltry 2.2% for the hedge funds.
In spite of the incredible record of passive low-cost investing in the stock market, it’s not for everyone. Some think the market is rigged. Others just won’t invest in something they don’t understand. Also, there are those who think there is more opportunity in alternatives such as crypto or real estate. But as a banker, I often saw four common reasons for not investing:
- Entrepreneurs often want all excess cash plowed back into their business. They are convinced reinvesting in their business offers better opportunities.
- Risk averse people can’t take the short-term volatility. It may be too gut wrenching to see a portfolio shrink 20% or more in a correction. If you can’t sleep when stocks are volatile, it’s not the place for you.
- Some don’t need to take any risk. They have sufficient cash flow, and other income for the life they want to live. They find it unnecessary to take on stock market risk. They may happily invest in CD’s or short-term bonds because they’ve won the race and don’t need to keep running.
- Salespeople may offer convincing presentations on investments like timeshares, whole life insurance or expensive annuity products that distract from the superior rewards of stock market investing.
But for the rest of us, there are five compelling reasons it’s good stewardship to be in the market.
First, the odds of the market going up are favorable. Here are some interesting stats put together by Seeking Alpha.
- On any given day, stocks have roughly a 53 percent chance of rising and a 47 percent chance of falling.
- Over any given 3-month period, stocks rise 68 percent of the time.
- Over a typical 12-month period, the odds of making money in stocks rise to roughly 75 percent.
As an investor, I like those odds. It’s like the reverse of a casino where the longer you play, the more likely you will lose. And the data is even more impressive over the long term.
Over any 10-year time period in the history of the S&P 500, there has been a 95% chance of a positive return. Over a 20-year term? 100%.
Finally, consider the S&P has averaged over 10% annual returns over all ten-year time periods. The worst 10-year return was -4.9. The total S&P return over the last 10 years has been 295%. For the long-term diversified investor, it’s a path to wealth with a record of limited downside.
Second, it’s helpful to think about the stock market as a way to invest in human ingenuity. Some of us are not gifted in creativity. But we can recognize the genius in those around us who innovate and make our lives better. And thanks to stock markets, we can invest in those creative innovators by buying stock in their companies.
Today, as market investors, we are riding the coattails of visionaries like Steve Jobs, Jeff Bezos, Elon Musk and nameless others who have not yet become household names if we own the total market.
What about those who want to express their ingenuity by starting or investing in a small business? Is that a better investment than the stock market? It might be, but there are big risks to consider.
Around 50% of new businesses fail within five years. For those who want to swing for the fences with a startup idea, the potential reward is unlimited. But the lack of diversification and risk of failure should be weighed against the risk and reward probabilities of a total stock market investment.
Third, consider the beauty of passive income that comes with investing. After John D. Rockefeller was forced to split up Standard Oil, he mused, “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”
The stock market is a place you can earn passive income through dividends by doing absolutely nothing after investing. All we need to do is buy and wait for the dividends to pour into our account.
Fourth, the liquidity of the stock market is something we might take for granted unless we are an entrepreneur wanting to sell a business. If you need to cash out of the stock market suddenly, it can be done in a day. If you need to sell your home or a private company? It may be costly and take time to find a buyer.
Without being a part of a publicly traded market, small business shareholders may or may not be able to cash in at a fair price. As a stock market investor, we enjoy reliable liquidity that ensures a fair market price.
Finally, just as small business owners take pride in their company, we should not think of our stock investments as numbers on a computer screen. They are investments in real businesses too. When we own a stock or index fund, we should take pride seeing our investments being used to employ others and create goods and services.
These are the reasons I love the stock market. There’s no guarantee on future performance, but it’s the best alternative in my financial toolbox for long term growth.
Joe Kesler