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Every five or ten years when the stock market declines, the alarmists start espousing the relative safety of CDs and money markets. Stocks, they argue, are far too risky for the average Am erican family and downright dangerous to the security of your nest egg. They make their proclamations at exactly the wrong time -- just when people should invest more in the market. But what the critics of the stock market don’t understand is that investing in so called “safe” financial instruments over the long haul exposes investors to a huge risk: inflation. Stocks do have risk, but educated investors will still end up far ahead by investing in them.
Historical Losses
Critics of the stock market often point out the large losses associated with a drop from peak to trough. One of the most famous ones in recent history being the drop in the S&P 500 Index from September 2000 from over 1,500 to October 2002 when it bottomed around 775 -- a 49% decline. While it was a stunning drop, the notion that the average investor suffered anything near that loss level is absurd. In order for that to happen, an investor would have needed to invest at the very top of the market and sell at the very bottom. In reality, most long term investors had losses on the order of 25 to 35 percent.
The decline was steep indeed, but the lowest level reached was the exact same level that the S&P was in April 1997. For long term investors, while it was painful, most only saw a loss of their previous gains. Any one that held the S&P in April 1997 was sitting on zero losses at the trough in 2002. Prior to that, they had seen gains of 100% in a mere two and one half years. For those that saw the unrealistic valuations that were placed on companies beginning in 1998 and accelerating in 1999, many either hedged or sold at elevated levels. Most long term investors continued to invest and hold their positions through the difficult markets of 2002 through 2004 to see most of their gains restored by 2006.
The fact is that over a very long period of time, stocks return about 10 percent annually. For patient investors and those who know when things have gotten overvalued, the rewards are huge.
Individual Stocks
It’s true that any individual stock can decline dramatically in value. Have a growth stock that misses its quarterly earnings report and you could see a 20% decline in a day. Risky? Yes, but not if you consider the potential upside. The same stocks that take a beating for missing earning figures by a penny can produce returns of 500 to 1,000 percent over a ten year period. Hold a diversified portfolio of these growth stocks and in the end, the portfolio will yield impressive returns.
Sure, you’ll have growth stocks that decline by 90%, but those were offset by the ones that gain 500%.
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