This is the best method for investing in stocks
Reprinted courtesy of MarketWatch.com
Published: April 20, 2019
To read the original article click here
One of the hardest things for investors to learn is just how unpredictable the stock market can be.
It’s easy to see what’s happening now, compare that with what has happened recently, decide you see a trend and conclude that the trend will continue.
When you do that, you’re sometimes correct. And you’re sometimes wrong. Oh, so very wrong.
One major thing investors should expect is to be surprised. Sometimes really surprised.
I’ll give you a handful of examples to make that point and — more important — show you what I think is the best way to cope with the unknown.
To keep things simple, I’ll focus on the history of the S&P 500 index SPX, -0.02%, the most widely used proxy for the U.S. stock market, from 1970 through 2018.
So let’s imagine a young person just starting out in 1970 with a plan to invest $1,000 a year, putting in $83.33 a month, and to increase that amount by 3% every year as her income went up.
In the first five years, 1970 through 1974, her savings would total $5,310 and but her portfolio would have been worth only $4,127.
She would have seen the S&P 500 go up in three years and then suddenly lose 14.8% in 1973 and another 26.5% in 1974.
It’s hard to know what she might have expected from the next five years, but she certainly could be forgiven for being less than enthusiastic about the market. At that point she could have bailed out of the stock market, and many people would have agreed that was the right thing to do.
But in fact, when you have a good long-term plan, as she certainly did, the right thing to do is stick with it, even when it’s uncomfortable and your friends think you should change course.
Let’s assume our investor did that by adding another $6,155 in 1975 through 1979. She would have been glad she did:
The S&P 500 rose 37.2% in 1975 and another 23.8% in 1976, with another gain of 18.4% in 1979.
By the end of 1979, her portfolio was worth $16,270, nearly four times what it was worth in those dark, discouraging days of 1974.
In the middle of the decade, few people would have predicted that outcome.
Let’s recap the 1970s in this table:
| THE ‘70S AT A GLANCE | |
| Average annual return | 7.4% |
| Best annual return | 37.1% |
| Worst annual return | -26.5% |
| Her cumulative investments | $11,465 |
| Ending portfolio value | $16,270 |
While her gains over those 10 years were far from spectacular, she did wind up with more than $16,000 that she would not have if she had spent the money instead of saved it. About 30% of her portfolio came from stock market gains, and the rest was what she had put in.
The 1980s were a quite different story — one with a happy ending she could not possibly have predicted. Assume she continued with her plan, adding another $14,064 over those 10 years.
Here’s the result:
| THE ‘80S AT A GLANCE | |
| Average annual return | 18.1% |
| Best annual return | 32.3% |
| Worst annual return | -5.0% |
| Her cumulative investments | $25,529 |
| Ending portfolio value | $120,320 |
By any historical standards, that average return of 18.1% is terrific for a 10-year period. In that decade, the market had three years of returns over 30% and another two with returns over 20%.
At the end of 1989, her portfolio was worth nearly five times the total of her savings and more than seven times what it was worth 10 years earlier.
All this resulted from a plan with modest monthly savings that continued, no matter what.
Do you think our imaginary investor would have been optimistic about the 90s? Most likely!
In the 90s, she would have added another $20,706.
| THE ‘90S AT A GLANCE | |
| Average annual return | 19.0% |
| Best annual return | 37.4% |
| Worst annual return | -3.2% |
| Her cumulative investments | $46,235 |
| Ending portfolio value | $689,226 |
Now her portfolio was worth nearly 15 times the value of her own contributions, and nearly six times its value at the end of the 80s.
By 1999, our not-quite-so-young-any-more investor would likely have concluded the stock market was a gold mine of easy money. Most investors would have agreed, and millions of them eagerly looked forward to the next 10 years.
I started the article by noting how easy it is to notice a market trend and expect it to continue.
When you do that, as I wrote: “you’re sometimes wrong. Oh, so very wrong.”
Starting in 2000 and continuing through 2009, our investor would have learned this lesson the hard way.
After dutifully adding another $27,825 in those years, here’s the result:
| 2000-2009 AT A GLANCE | |
| Average annual return | 1.1% |
| Best annual return | 28.7% |
| Worst annual return | -37.1% |
| Her cumulative investments | $74,060 |
| Ending portfolio value | $649,360 |
If you compare those figures with those of 10 years earlier, you can see what a shock this decade was for investors. In fact, many people bailed out of the market after the 37.1% decline in 2008.
Mistake!
The market rebounded by 26.3% in 2009 (otherwise, the figures in the table above would be much worse), and that turned out to be the start of the longest bull market on record.
But who would have seen that at the start of 2010?
In the nine years from 2010 through 2018, our theoretical investor bravely kept contributing month after month, adding another $33,140 to her savings.
| 2010-2018 AT A GLANCE | |
| Average annual return | 12.1% |
| Best annual return | 32.3% |
| Worst annual return | -4.5% |
| Her cumulative investments | $107,200 |
| Ending portfolio value | $1,798,679 |
Those nine years added more than $1 million to her portfolio.
Here are some lessons I take away from this.
ONE: This outcome would not have happened if our investor hadn’t stuck to her plan through thick and thin. At times, doing that must have been hard. At other times, it must have seemed exhilarating.
TWO: The recent past is unlikely to be a good predictor of the future.
•The early 70s were a lousy guide to the late 70s.
•The decade of the 1970s didn’t begin to predict the success of the 80s.
•The 80s were in fact a pretty good predictor of the 90s.
•The 90s were a terrible predictor of the first decade of the 21st century.
•That awful decade gave no clue to the great bull market of 2010-2018.
THREE: Sticking with a plan is much easier on paper than in real life. Three times in the period 1970-2018, the S&P 500 lost more than 50%.
FOUR: Without warning, the stock market can take off like a rocket. Remember the 1980s.
FIVE: But also without warning, the market can go into a tailspin. In just one day in 1987, the S&P 500 lost more than 22%.
SIX: You never know when the good times are going to roll.
After the fact, the experts will explain it all and make it look obvious. But at the time, most people will scratch their heads in wonder.
The bottom line: Have a good long-term plan and stick to it.
For more commentary and lessons, check out my latest podcast: “How realistic are your expectations for future returns?
Richard Buck contributed to this article.
Purchase on Amazon
Sound Investing Podcast