This is probably the most common question you get from people who are considering starting to invest in stocks. It’s pretty understandable; you work hard for your money and the idea of it disappearing into the black hole of an unpredictable and often times not-well-understood stock market is pretty hard to stomach. Add on that scars from the 2008 Great Recession, 2001 Internet Bubble, Black Monday in 1987, Black Tuesday in 1929, and on and on and on.
So, what’s the answer to the question: Who knows? The stock market is unpredictable and no one knows what will happen in the future. That’s not an especially satisfying answer, but it’s the truth. If I could predict the stock market I would own my own island in the Caribbean next to Johnny Depp’s.
But I can hear you saying, “Come on, you’re Stocky Fox. You can do better than that.” You’re right. I’m taking on the challenge and answering the question: Will you lose money with the stock market?
I won’t try to predict what will happen in the future, but I think you can look to how things have behaved in the past, and get a pretty good perspective. Of course, there’s no certainty that the future will be like the past, but that’s the best we have to look at.
You can get somewhat decent data on the stock market going all the way back to 1871. Back then, your great-great-great grandfather was getting The Stocky Fox as a newsletter delivered by the Pony Express. Going that far back, you can calculate the percentage of the time that you would have lost money investing, historically.
So imagine starting in January 1871 and investing $10 every month in the US stock market. By January 1872, you would have invested a total of $120 and your stocks would be worth $128; congratulations, you just made a profit. You can do that for every 12-month period since 1871 (there are about 1700 such periods), and you come out ahead 71% of the time, which seems pretty good. But the flip side is that you’d have lost money 29% of the time, and at least to me that is too high to be really comfortable.
However, remember that when investing stocks, time is on your side. Do the same exercise but for five years; if you started in January 1871 after 5 years you would have invested a total of $600 which would be worth $679 in January 1876 (yeah, profit again!!!). Do that for every five-year time period and you end up losing money only 13% of the time. By adding another four years to your investing time horizon that decreased the chances that you would have lost money by 20%!!! That seems pretty amazing.
You can keep doing that for longer time periods, and as you could guess, the percentage of times you would have lost money keeps going down. Astoundingly at the 20-year mark, you would have lost money only one time out of the nearly 1500 periods possible (the one month was June 1912 which, you guessed it, was 20 years before the Great Depression bottomed out). At 30 years, there isn’t a single time period where consistent investing would have lost money!!! That’s not a misprint. Read that paragraph again.
There are no guarantees, but if you use history as a guide, it’s pretty much a sure thing that you’ll make money in the stock market. Certainly it involves a lot of discipline, investing month after month no matter how bad things look (dollar cost averaging). Also, it doesn’t necessarily mean you always make a lot of money, but the data seem pretty powerful. Additionally, I didn’t take inflation into account so that would definitely skew the numbers downward (but you know how I feel about the integrity of the data on inflation, so there you go), but the message remains largely unchanged.
I must confess that I was a bit surprised by the data. Actually, I spent about 30 minutes going through the spreadsheet to see if I made any mistakes; I’m pretty confident the analysis is sound. As Dr Brown asked Marty in Back to the Future, “Do you know what this means?” (just don’t take what he says after that and apply it to my analysis). If your time horizon is 20 years or more, at least based on history, there’s virtually no chance that you’ll lose money. I figured it would be a pretty low chance, but zero chance? I didn’t see that coming. Even people who invested for 20 years then pulled out after the Great Recession in 2008 did fairly well (invested $240 which became worth $339).
So there you go. My answer to the question posed at the top is still: No one knows what the future holds. But the historic data confirms my personal belief that the stock market is a really great place to invest your money. I lose no sleep worrying about the Fox family’s investments increasing in value. I know over the long term they will.
What about stocks vs. REITs or Commodities?
Good question Foxy Lady. Obviously real estate has been around for a very long time, certainly longer than stocks, but REITs are a bit of a recent development. I don’t know exactly when the first REITs hit the market, but just for the sake of comparison, Vanguard launched its REIT fund in 1996 (it launched its S&P 500 fund in 1976, so that gives you a sense of it). To do this type of analysis you need a lot of history, and REITs just don’t have it (or at least not that I can easily find). So I don’t know what this analysis would look like for REITs. My sense is that it would be a little less volatile with a slightly lower return, but that’s just my guess.
Similar story with commodities. Broad commodity funds like DJP are pretty recent guests to the party, so there isn’t enough history to do this analysis. However, the components of most commodity funds, especially things like gold or oil, have a ton of data available. I haven’t run the data, but I would bet a paycheck that investing in oil or gold over the long term wouldn’t do near as well as stocks. Commodities really aren’t good investments (in my opinion), but rather they serve as an investment hedge against inflation.
Well written, Stocky; good job. I’ll suggest though that not doing this in real terms hurts you though. I see you have thoughts on reliability of inflation data, but I think we can all agree that while exact precision might be an issue, over 30 years the inflation effect is tremendous, and not taking that into account really makes the nominal analysis quite limited. I also think you need to make this a continuum too (not binary) – even if you did this in real terms, your chart simply says “won” or “lost,” but does not offer gradations. I will not be happy if in 30 years I made $1 more than I put in (which would be counted as a “win” in your methodology). Lastly, this could benefit from more nuance based on time horizons; there’s a reason they say to transition to fixed income the closer you get to retirement: if you’re 5 years away from retirement, the money you put in from now til then is subject to your 5 year loss projection, and that’s not excused by the weighted average of the first 25 years pulling up that mean.
Andrew H–You make a lot of really good points. I bet you were the smartest guy in your junior high school.
Definitely including inflation would reduce the percentage of “profitability”, there’s no question. As I mentioned in the post “Inflation won’t be as bad as everyone thinks,” I think most people way over estimate the impact of inflation. Also, you tend to have a problem getting good data. The CPI started in 1919 so you can’t go as far back as I did in this analysis. The data I used comes from Robert Schiller and he does estimate the CPI back to 1871, but that shows the US was in deflation for over 40 years until the 1910s. That just doesn’t smell right, so I wouldn’t trust that analysis. However, I would trust it since 1930 . . . hmmm, maybe that’s a topic for a future blog post.
I similarly agree with you on the notion of not just having “profitable” or “not profitable”. Definitely the analysis would be better showing the distribution of returns. I just couldn’t find a good way to show it while also showing the analysis for different time periods (1 year, 5 years, 10 years, etc.). Consider that analysis included in the post when I adjust returns for inflation. The lengths I will go to for my loyal readers.
As for your last point on transitioning from all stocks to more bonds, again I totally agree (that’s why “Asset Allocation” won the investing tournament). However, for this analysis I was trying to keep it simpler. So many people are afraid of losing money in the stock market (either nominally or in real terms). If you’re 35 and planning on retiring in 65 years, what is the likelihood you’d lose money if you started putting money in the market? What if you were 45? Certainly I would never recommend that either scenario invest all in stocks the whole way. However, I hope it illustrated the more fundamental point that over time, the probability of making money with stocks is very high.
Thanks so much for reading. I look forward to more of your comments.