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Personal Stuff: The market mellows over time

Why buy stocks? They move erratically, often wildly up or down often without any apparent relationship to the profits or progress of the companies whose ownership they represent. Some who read my views on investing earlier this year must be wondering if I’ve changed my tune, or gone broke following my own advice. 

Well, 2000 certainly didn’t deliver the kind of market anyone expected, although many analysts hedged their bets for most of the year because they could no longer predict what was going to happen. But the reality is that if you are truly a long-term investor, and not a trader, it doesn’t really matter. Take a good, long look at the chart below.

This chart, provided compliments of David Roth of Liberty Capital Management in Santa Ana, CA (949-724-8848), shows the risk exposure from investing from 1926 through 1999. 

The chart shows that small company stocks are most volatile and T-Bills, representing cash, are least volatile. No surprise there. 

But let’s go in a bit deeper. We can see that average investment returns over the short (1-year) term – blue bars – are greater for small stocks than for large stocks, and both are greater than the average returns for bonds (or cash, duh). But it also shows that potential losses are greater as well. Small stocks over a 1-year window have returns approaching 150% and ranging all the way down to minus 60%, a scary thought if you are holding during the declines. Large stock average 1-year returns ranged from 54% to minus 43%, a narrower range but still pretty wide if you own them. So far we’re not exactly breaking new ground here. 

But take a look at the narrowing ranges of price fluctuation as you hold these same kinds of investments for longer periods. Just a 5-year average holding period (green bars) cuts the range of fluctuation by more than half, and reduces the downside risk of small stocks to 29%, and large stocks to 12%. The upside in both cases is still quite handsome.

Now look at the pink bars representing the 20-year timeframe. For these longer holding periods, there is on average minimal risk of loss, regardless of the type of investment. In fact the only loss exposure for 20-year holding periods is in bonds and cash, because of their fixed rates of return and inflation, respectively. 
So, now that I’ve quoted more statistics than in the last 3 issues combined, what’s the point I want to make here? 

Sound companies provide a basis for solid returns over the long-term because they grow, earn profits and become more valuable. Over the long-term, the overreactions of the market are self-correcting, and only the basic value remains. If your investments are in growing industries, sound companies and well-placed products and technologies, you will be very well rewarded for your foresight and your patience. 

And that’s the name of that tune…

Ed. Note: We are not investment advisors, and nothing herein is intended to imply recommendations as to specific investments. Further, we emphasize that these are averages, and any given investment might have done better, or worse, than the averages. 

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