Want to learn a guaranteed way to never, ever lose money in the stock market?
Then today’s post is for you.
Those who have read about the magic money machine will remember this graph:
It’s a good representation of the random walk the stock market follows every single year.
Some years are great. Some are absolute disasters. And many other times, the market keeps wibbling and wobbling, seemingly unable to make up its mind.
As the above graph is a time series, let’s try and represent the data in a different way:
What the graph above tells you is the following:
In the past 94 years, the maximum one-year loss for the S&P 500 was an astounding 43% decline back in 1931.
Make no mistake: losing 43% of your money is an absolute zinger. After that sort of a hit, you need a return of 78% just to break even.
Over the same period of time, the maximum annual gain for the S&P 500 was an equally impressive 54%. The year was 1933 and the market was rallying on the back of the New Deal.
If you take a broader view, the market lost money in 25 of the 94 years, or roughly a quarter of the time. However, it posted a gain in each of the other 69 years, translating into roughly a 3-1 “win-lose” advantage.
Both the distribution and probability of returns demonstrate a skew to the upside. However, to call it a rollercoaster ride would be an understatement.
Thinking In Pairs
Now let’s see what happens if we extend the investment horizon to two years.
That is, what happens if one was brave enough to put some money in the S&P on January 1st – and follow up with another investment a year later, no matter what happens in the meantime?
You’ll have to squint to see the difference, but it’s there. Those lucky enough to have caught a good stretch would walk away with an annualized gain of 41%.
Those less fortunate could lose a whopping 39%, also annualized.
Interestingly, there were only 15 two-year stretches that would lead to a loss of any principal. In all other years, roughly 84% of the time, an investor would have made money.
But two years is still a very short stretch, at least as far as the stock market is concerned. What if we extend the horizon even further?
A Long Term View
I’m not one for suspense, so here’s a chart that summarizes the range of outcomes for an investor patient enough to invest with a 5, 10, 15, and even 30-year perspective in mind.
That means buying – and continuing to buy, no matter what happens to the market.
The 5-year period is clearly the inflection point.
Sure, the maximum annualized gains come down to 28% (in other words, the kind of returns hedge fund managers would kill for these days).
However, it’s the reduction in downside risk that’s most impressive here. As a function of simply holding one’s nerve, the maximum possible annualized loss declines to 9%.
It’s far from ideal to lose 9% per year for five years. But compared to a 39% loss in the preceding column, the impact is dramatic.
This is why five years is usually used as the minimum time horizon for stock market investors.
By now, you know how this story will go. The longer you stay invested, the lower the spread of returns – but the higher the probability you will end up making money.
Have another look at the second last column of the graph. Over the past century, there hasn’t been a single investor with a 15-year investment horizon who would have lost money in the S&P 500 – provided they held their nerve.
And those who were patient enough to invest for 30 years in a row would have walked away with a minimum annualized return of 9%, and potentially much, much more.
Let that sink in for a moment. By definition, anyone who starts in their 20s has an investment horizon of far beyond 30 years.
All that matters is staying invested.
For as long as the stock market has been in existence, there have been people claiming to have the proverbial philosopher’s stone. Of course, the bummer is that the folks who actually know how to beat the stock market don’t need your money.
But that’s okay – because the only secret you need to know is out there in plain sight:
Buy. Hold. Rinse and repeat.
You simply cannot lose.
About Banker On Fire
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Banker On FIRE is an M&A (mergers and acquisitions) investment banker. I am passionate about capital markets, behavioural economics, financial independence, and living the best life possible.
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