Take a look at this chart.
I’m always amazed by it, no matter how many times I’ve seen it.
It’s the value of $1 invested in the S&P 500 index since 1950. One buck turned into $1,216, without any input, skill, or decisions from the investor who owned it.
1 Dollar in the S&P 500
You can call this chart The Reason We’re All Here.
We’re investors in the stock market because it has a long, time-tested history of generating big returns for those patient enough to let compound interest work its magic.
But ask yourself: Why are these returns even possible?
Why are we so lucky to enjoy these returns?
The Giant Bill You Never See but Pay Every Day
Almost everything in the economy has a price tag. The nicer the thing, the higher the price. And the stock market, over time, is a pretty darn nice “thing.”
Why doesn’t enjoying these big returns have a price tag?
In fact, there is a big price tag on these returns. It’s just hard to keep track of.
Everyone knows the stock market is volatile. But a chart like the one above doesn’t do a good job depicting how much chaos and misery investors had to endure to capture the full long-term return.
This chart — over the same time period as the one above — shows how much the S&P 500 was below its previous all-time high on any given day (periods at 0% are when the market is at a new all-time high):
S&P 500: Percent Below Previous All-Time High
It’s a mess. Total chaos.
During this period, when the S&P 500 increased more than 1,200-fold, the index spent just 6.2% of trading days at a new all-time high. Here’s how the rest of days fared:
|Percent of Total Trading days, 1950-June 2017|
|New all-time high||6.2%|
|0%-10% below previous all-time high||34.8%|
|11%-30% below previous all-time high||35.6%|
|31%+ below previous all-time high||23.4%|
Earning excellent long-term returns required putting up with having less money in your account than you did at some point in the past 93.8% of the time.
That’s the cost of long-term returns in the stock market.
Checking your account, wondering what happened.
Remembering how much more money you used to have.
Kicking yourself for not doing something different.
Agonizing over whether the pursuit of long-term investing is actually worth it.
Watching your net worth decline, sometimes by a lot, and fairly often.
You don’t pay this cost in dollars and cents. Its currency is stress hormones. But it’s a very real cost.
Bang for Your Buck
A smart way to defray the cost of long-term stock returns is through diversification into less volatile assets, like bonds or cash.
But the cost of long-term returns in the stock market will always send you a bill, no matter how much or little you own.
There are two ways to view that cost.
- Consider it a fine, like something you should try to avoid and feel guilty for paying.
- Consider it the cost of admission, like something you are happy to pay because it’s worth the price.
Many investors probably fall into the first camp. They trade in an out of the market, trying to avoid any declines. They consider a losing month, quarter, or year as a sign that they did something wrong or were cheated with bad advice, changing their investment strategy to avoid paying another fine.
Fewer investors fall into the second camp. But it is, for most investors, the wisest way to invest. The long-term history of market growth even in the face of constant drawdowns is why.
View market volatility as a fine, and you’ll spend your life jumping in and out of your investments, likely missing some of the best returns as you fret about paying the bill.
View it as the cost of admission and you will likely realize over the course of many years that you may have purchased tickets to one of the greatest shows capitalism has ever produced, with encores for those who stay through the end.