Is It Safe to Invest in the Stock Market?

Opinions about the stock market range from unreasonable fear to ridiculous optimism. Reports of people who made incredible amounts of money in the stock market as well as those that lost everything can be found in publication after publication. So what is the reality? Is it safe or dangerous to invest in the stock market? And if it is safe, what is the best way to invest?

Here is the truth about positive returns and the stock market: the longer the time horizon of investment, the safer the stock market is.

Since 1928, on a yearly basis, the stock market has resulted in a positive return 61 times and a negative return 29 times. Therefore, if you plan to invest in the stock market for only a single year, you have a roughly 30% chance to lose money and a 67% chance to realize a profit. Those are not good odds. I do not recommend investing in the stock market for short term gains. 

The average stock market return since 1928 is 7.6%. The average return in a positive year is 18.5% and the average return in a negative year is -14.7%. From these numbers, it is apparent that the stock market tends to swing rather dramatically. The best and worst years in the stock market came within two years of each other during the Great Depression. In 1931, the stock market lost 47.1% and in 1933, the stock market gained 46.6%.

If we broaden the investment horizon into five year periods, there are 74 periods that resulted in positive returns and only 14 periods that resulted in negative returns. For a five year period, there is an 84% chance of realizing a positive return. Average positive returns are 10% and average negative returns are -4%. The worst five year period started in 1928, just as the Great Depression  began and the best five year period started in 1995 as the internet boom was starting.

For ten year periods? There were 79 periods with positive returns and only 4 with negative returns. That is a 95% chance of positive return. The best ten year period was a 16.9% return starting in 1989 and the worst ten year period was -1% starting in 1999 when the internet bubble burst.

For even longer period, there is only one fifteen year period that resulted in a loss. That was in 1929 with the beginning of the Great Depression and the loss was -0.85% over that time period. There are no losing periods longer than fifteen years. 

Some have suggested that looking all the way back to 1928 gives the wrong impression since in 1972 we moved off the gold standard and our financial system changed in a dramatic way. There is not a massive difference when only considering the stock market since 1972, but there are some key points. Whereas the average return since 1928 has been 7.6%, the average return since 1972 has been 8.7%. Also, the odds of a positive return in the stock market go up if only returns since 1972 are considered. One year returns go from a positive return 68% of the time to 74% of the time, five year returns go from a positive return 84% of the time to 89% of the time, ten year returns remain at 95% of the time, and fifteen year returns or longer go from positive returns 99% of the time to 100%. 

What does all this mean? If you plan to leave your money alone for five years or longer, then the stock market is very safe. But the key is to leave your money alone. Don't attempt to time the market through buying and selling constantly. Fidelity did a study that found that among their customers, those that performed the best in the long term were those customers that forgot they had a 401k with Fidelity. The lesson here is that those that just leave their money in the stock market through good and bad years end up with the best returns. There is a simple reason for this: people are terrible short-term predictors. But what I can predict confidently is that over longer periods of time, based on historical data, the stock market wins. Over short periods of time, no one knows.

Three Suggestions for Investing in the Stock Market

1. Make sure your investment time-horizon is longer than five years.

2. Continue to add to your investments during good and bad times. 

This is often called Dollar Cost Averaging. There are two reasons to use this strategy. 

First, people often stop investing when the stock market is good because they think returns are too good to be true. However, bull runs tend to last for years, and withholding regular contributions because you are scared of how high the market is and that it might fall is an unreasonable fear. The market, by its very nature, will continue to hit all time highs as long as it exists. Populations grow, economies grow, inflation grows and if all of that stops, it means we have entered Armageddon and your investments won't matter at that point anyway.

Second, by investing in regular intervals, you are also buying at cheap prices when the market declines. This boosts your future profits. 

Remember, since we can't predict the future, by buying on a consistent basis (monthly/quarterly) then we don't have to predict anything, we will naturally be buying both tops and bottoms of market peaks and valleys and will even out our returns instead of trying to guess what a good price is. 

3. Re-Allocate on a regular basis.

This is a more advanced strategy for those that enjoy really digging into their own investments. If you manage your own investments, you should have a benchmark of what percentage of your total portfolio is going to specific stocks or funds. Over the course of a year, some of those funds will rise, some may fall skewing the original percentages you set for investment. On a yearly or semi-annual basis, you will want to re-adjust those funds to match your benchmark again. What this does is take money from the over-performing funds and puts it back into underperforming funds. 

The reason for doing this is to average out big wins and losses. Funds with big winning years rarely keep up that run and under-performing funds often make corrections and can out-perform in future years. Buy re-allocating you are taking the great performance of one year in one fund and giving it back to a under performer which will boost its overall performance when it later has a breakout year.

Summary

Is the stock market safe? Yes. If you plan to leave your money alone for at least five years or longer, it is a very safe investment. But you need to choose good funds and you need to set it and forget it so you don't give in to the pressure to sell when the stock market is in decline. A century of historical data teaches us that there will always be positive long-term returns.