Most people find stocks attractive as it promises quick money to be made. It is only when they get into the market and lost money that they realized that money does not fall from the sky. On the contrary, the bookstores and the press are not short of successful stories about someone raking millions from the market. This gives constant motivation to the public that there is still a chance for them to make it big in the market. I would say for most people there is a love and hate feeling towards stocks. So, can stocks really build wealth?
The answer is yes but there is a condition.
A condition that is not 100% guaranteed but has a rather high success rate – that is to hold stocks for the long run. You probably heard it often that it even turns you off. But before you hit the button for another site, allow me to convince you. I have to let you understand why stocks is still going to be your favourite wealth building avenue.
Jeremy Siegel wrote a very easy to understanding book, “Stocks For The Long Run“, which pretty convinced me. So it is my turn to spread his words and convince you too.
Reason #1 – Stocks beat bonds and treasury bills returns
Most of us understand that stocks perform better than bonds and bills. Bonds and bills have been referred as safe havens due to the fact that the return is largely fixed. In life, certainty comes with a price, and in this case is lower returns. It is when stocks that are not doing well that bonds and bills flourish. This is because everyone get hurt with stocks and want to switch to something that offer a return (even though it is small, it feels better than seeing your capital tumble down with the stock price). This is a mistake because even during historical crashes in stock market throughout history are merely small dips in a long term chart. To quantify what I meant, there are figures that I like to quote from Siegel’s book – $1 invested from 1802 to 2006 in the various instruments will bring about the following real returns in US:
Stocks – $755,163
Bonds – $1,083
Bills – $301
Gold – $1.95
If you think it is because of the phenomenal economic growth in US in the past century that gave such returns. You should be convinced when “Triumph of the Optimists” reported that stocks readily beat bonds and treasury bills in 16 countries being surveyed. With South Africa, Australia and Sweden having a higher stock returns than the United States.
Reason #2 – Stocks have lower risk than bonds and treasury bills (in the long run)
This reason was briefly mentioned in a previous post – “Why Buy Stocks For the Long Run?” To put it more obvious, you can look at the following chart taken from “Stocks for the Long Run“:
Maximum and Minimum Real Holding Period Returns, 1802-2006
The chart shows the best and worst return for stocks, bonds and bills, for various holding periods (1, 2, 5, 10, 20 and 30 years). The important thing to look out for is the worst return actually reduced as the holding period gets longer. It is more significant for stocks, such that it is almost impossible to lose money if you hold stocks for more than 20 years (you can see the worst case is a +1% for 20 years and +2.6% for 30 years). You can still receive negative returns for bonds and bills for the worst case scenarios, so much for being safe assets. For shorter periods of holding, stocks have proven to be much more volatile than bonds and bills. The best case and worst case scenarios for stocks are largest at both ends. Therefore, the bottomline is that holding stocks for long run can ride off the risks and give you much better returns.
Think about it. If you so decide to be a long term investor, you have to be patient and ride through crashes. Do not convert your stocks to bonds after a crash. It feels more comfortable but it is a wrong thing to do. You can sell before crashes and buy thereafter, but the problem is not many people can predict when the market tops. Hence, holding on for 20 or 30 years is a safer and a better bet.
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The above holds through if you have a portfolio of shares that is updated over time (eg. like component shares in STI index).
If you hold just a single share or even shares in certain industry sectors, those specific shares may not do so well in the long term (eg. some companies or industries die out). That’s why the STI component shares are not fixed but change over time.
Also, the above is true if you hold for very long term. If you hold for medium term (eg. 10 years), you will find you have made a net loss from the great crash of 2008.
The safer way is to invest when shares are clearly cheap (eg. in the current recession) and sell when they are clearly expensive (eg. in the bull run) – ie. buy low, sell high. However, don’t try to catch the bottom or the peak. Just do dollar averaging buying during the recession for say 1 year and then wait till bull run, then do dollar averaging selling for say 1 year. In between, just collect dividends.
Seems like you are a cycle investor. On buying specific companies, I believe it is possible (Buffett has shown it time and time again) but there must be diligence to scour through stacks of annual reports. Of course, if one is not confident, an index fund will be more ideal.