Is the stock market safe?
If you’re asking this question, it’s probably best to save you a bunch of time just in case your friend sends you a cat video and you don’t have time to finish reading the whole article.
No, the stock market isn’t safe.
It isn’t safe for amateur investors. It isn’t safe for professional investors. Both groups can lose massive amounts of money in a short period of time. If you need access to your money at any point within the next one to three years, that money should not be anywhere near the stock market, and even expenses three to five years out should be carefully weighed before putting money into stocks. What data backs this up?
Let’s look at the history of stock market performance. By “stock market performance,” we are going to use the S&P 500, a stock index that measures a broad basket of American companies. And we’re going to use the phenomenal rolling return calculator at Don’t Quit Your Day Job to do so since it allows us to look at returns over any period of time, calculated on a monthly basis. And we are going to look at these numbers using reinvested dividends, and not adjusting for inflation, since we want to see the raw total return numbers. Since its inception, the S&P finished with a negative total return just over 27 percent of the time. Yes, your median return is 10.894 percent, but there’s a decent chance you fall flat on your face instead of realizing anything near that. Looking at total return over a shorter period of time (just six months) the S&P as negative over 30 percent of the time. So if you are saving for a down payment that you need to make six months from now, do you want a three in ten chance that you lose money on that investment?
“Ok, I get it. I need to keep short-term money out of the market because it’s dangerous. But why aren’t you mentioning anything about long-term money?”
Ah, I’m glad you asked, Imaginary Question-Asker. Using the same calculator as above, the S&P is negative 15 percent of the time over a three-year period. So that helps to explain why it still is irresponsible to invest in the markets for expenses over the one-to-three year time horizon initially mentioned. Even over the five-year period mentioned above, the S&P is still negative 10 percent of the time. That means you have a really, really good chance of making money, but you still need to factor in the potential for loss since it does happen one in ten times. Short-term money has no business being in the market. But when we go out to longer timeframes, the power of the market could work in your advantage. Over a 10-year period, the S&P total return has been negative just 2 percent of the time. And during those 10-year periods, it has produced a median return of 8.468 percent per year. Over 15-year rolling periods, it has been negative less than 1 percent of the time, producing a median return of 8.295 percent per year.
Markets are really unpredictable in the short-term.
But they are decidedly predictable for long-term investments, while also generating returns in the high single digits. Any good advisor worth their salt will tell you that they realistically don’t know what the market is going to do today, tomorrow, next week, next month, or next year. That’s because it’s really hard to figure that out, and the consequences associated with being wrong can be pretty significant. But the short-term volatility is the price you pay for the consistent long-term returns you can generate if you are patient and don’t need access to the funds in the near future.
If you’re saving for a car or college and need the money in a year or two, don’t put it anywhere near the market. But if you have expenses that are 10 or more years out, and you have other funds that can cover your short-term expenses, then you are in a position where you can handle the short-term fluctuations of the market in exchange for the returns it produces over long periods of time – assuming you don’t panic when the market is down and sell all of your stocks. But that’s a “you” problem, not a market problem.