The Real Risk of Stocks
People greatly overestimate the long term risk of owning stocks. And much more insidious, people seriously underestimate the long term risk of not owning stocks. Hey, everybody, and welcome back to another episode of Retirement Answers. My name is Jacob Duke, and I'm a certified financial planner, and I help people just like you retire on a daily basis. And today, as you can probably tell by the title, I wanted to talk about investing and whether or not it's risky or perhaps what if there's no risk at all involved with it.
Jacob:Whenever we talk about stock markets or equities, we think about, oh my goodness, I might lose all of my money, because the market goes down or because there's a war going on or because this person's the president. All those things come into our mind, and we're just flooded with headlines and news articles about all those topics saying that this event, this thing that's happening is gonna cause the end of the world and your accounts will go down because of it. So that's what we're gonna be talking about today. But first, thank you so much for tuning back into the show. If you're enjoying it, I would really appreciate it if you go give a review and rating there on Apple Podcasts, if that's how you're listening, and then share it with a friend as well that might find this helpful.
Jacob:But also if you ever have questions or if I can help in any way, I would love it if you reached out. I'd be happy to answer any questions. The best way to do that is just send me an email. My email address is Jacob.Duke@appliedcapital.com. You can send me a question there.
Jacob:Happy to answer that for you and then, make sure you are making the best decisions possible around your finances. So, with that being said, let's go ahead and jump into today's show. So we're all worried about the risk that we're taking whenever we invest in stocks. See We our account balances go up and we see them go down just like we did back in 2020. At the beginning of COVID, we saw that the stock markets went down about 33% in a matter of thirty days.
Jacob:That's not very long of time whenever the market has gone down that fast. That's a really quick steep drop. Also in 2022, we saw that the market went down about 20%, over the course of the year. And that's just another instance of the volatility that is out there in the markets. But is this thing called risk actually real or is it made up in our minds?
Jacob:Like, we amplify what risk really is? And do we make more of it than we truly should? Well, we all know all the stats. US stock markets have provided around a 10% annualized return over the last thirty years, right? So that's kind of any thirty year rolling period.
Jacob:You can expect somewhere around a 10% average over that thirty years. Now, we know that averages are not completely representative of the markets. We are constantly met with headlines that are telling us that the current crisis of the day is gonna be really what ends the world or your accounts are gonna go down by 50%. Well, we all know that that 10% average over time, but we don't actually get 10% every single year. There are plenty of years where the market's down 30% and there are plenty of years where it's up 30%.
Jacob:So all those ups and those downs, they average out to around 10% annualized increases over long periods of time. But we think that markets are risky because we only see what's happening right now today or last month or last week or last year. And we see those downturns and we're like, man, I just cannot do that. I can't bear to see my account go from a million dollars to 800,000. I can't bear for my account to go from, you know, $600,000 to $450,000.
Jacob:That is hard to deal with as an investor. So we naturally think that all stock markets are risky because occasionally those downturns happen and we think we've lost our money forever. Well, what if I told you that stock markets are not as risky as you think, and perhaps they might even be riskless. Like, yes, you heard that right there. What if there's no risk, in terms of investing in the stock market?
Jacob:I know that's a crazy thought, but please hear me out. We know that The US stock markets have provided those 10% returns over long periods of time, which is great. But you might be saying, Jacob, I have to withstand so much volatility to get that. I don't know if I can handle it. Well, there might be a way to combat the volatility or the quote unquote risk that is found in the stock market.
Jacob:So here's a little bit of information and data on that. What this is gonna be explaining is the percentage chance of the stock market being positive after a certain amount of time? So it could be daily, monthly, yearly, and then, you know, a number of years beyond that. What what's the percentage chance of the stock market going up over that amount of time? So since 1926, The US stock market has experienced positive returns 56% of the time on a daily basis.
Jacob:So that means any given day, you have greater than 50% odds of the market going up that day. So that's better than a fifty fifty chance. And then 63% of the time on a monthly basis, there's positive returns. So as a month has gone by, instead of just one day, there's a higher percentage that the market will be positive. And this continues onward.
Jacob:So 75% of the time on a yearly basis, you will receive a positive return in the stock markets. So what that equates to is three out of every four years, you're gonna have a positive return in the stock market. So you can't afford to necessarily be out of the market during those three years. And we continue on and we see 88 of the time on a five year basis. So any given five years, 88% of the time, there will be a positive return in the stock market.
Jacob:And then it gets even crazier. So 95% of the time on a ten year basis. So any rolling ten year period, there's a 95% chance that you will have positive returns in stock markets. And then finally, on a twenty year basis, 100% of the time you will have experienced positive returns. So Jacob, whenever we say, hey, stock markets are riskless, what do we mean by that?
Jacob:Like, there's no risk. Well, what if we said if we hold our money for at least twenty years or longer, we will have a positive outcome. That's what history has shown us since 1926. That's what the data tells us. Now, obviously, anything can happen in the future.
Jacob:History does not have to repeat itself. But if there's any indication of what could happen in the future in the stock markets, history is the best thing we have to go on. So this right here is telling us that any given twenty years since 1926, any rolling twenty year period, 100% of the time the markets were positive from start to end. And that should be empowering to you. So obviously that's just historical data, but it's also a really large sample size and a lot has transpired during that one hundred year window of time.
Jacob:You know, we've had wars, we've had changes in political landscapes, we've had all kinds of different things happen over that hundred year period. But still, any twenty year period, we're still experiencing a 100% chance of having a positive outcome in the stock market. So how can I say that stocks might be riskless? Well, if you invest long enough, the volatility of the stock market goes away. It doesn't matter because you've invested long enough, the ups and the downs become a lot smaller because over time you're gradually creeping upwards in the stock market.
Jacob:So the first point I wanna make here today is that time is the great equalizer. In the long run, the risk that you should be worried about is not losing your money in the stock market, or what we might call principal loss, like you're losing your principal investment. The risk that you should be worried about the most is the extinction of your purchasing power while you're still alive. We've all been taught to fear the stock markets. What if I lose all of my money?
Jacob:But when we really get down to it, pessimism is not realistic. Look at all of human history. Despite being up against great odds, we've survived and we've flourished as a culture, as a people, And because the stock markets are made up of companies that operate in this world of continuous improvement, we know that their valuations will continue to increase as well. So as an investor, once we understand this, we can all agree that optimism is the only realism. The only choice is to be optimistic about the future and about markets.
Jacob:And might I add that the people who win when it comes to investing are the optimists. Those who are always complaining about the current state of our world, our economy, political landscape are the ones that are always sitting on the sidelines waiting for the quote, correct time to start investing again. And all this time is going by and the wealthy people, the ones who are making money in the market, they're invested and they're investing more. And the good news is is you get to choose which person you wanna be. Do you wanna be the person who says, you know, I know there's a lot going on currently in our current world, in our current environment, but I know that history is a good indication of what perhaps could happen in the future.
Jacob:I'm gonna place my bets on that and say that regardless of all the bad things that are happening currently or will happen in the future, there have been plenty of bad things that have happened throughout our past, but the markets have continually improved, grown and increased in value over time. So if we understand that, and if we agree that in the long run, stock markets aren't very risky, we can also agree that in the short term, anything can happen. So how do we become a wise investor and eliminate those short term risks? Well, number one, it's that you should be a long term investor or have a long term mindset. You have to be in it for the long haul.
Jacob:And to do that, you need to have a system in place to help you do it. We literally have zero control over the stock market. There's nothing we can do to make it go up or go down as individuals, maybe as a large collective group of people, which means like the whole country of The United States perhaps banding together and say, we're not gonna buy anything from a store ever again. Outside of that, we have no control over, how companies perform, as individuals. We cannot make a big enough dent on them in terms of their revenue or making their stock prices decline.
Jacob:And we also can't predict what will happen in the future based on our current situation or what we think might happen. There's no way of knowing. You have to understand, there's no way of knowing the future. And if we think we will, and if we think we do, we're probably lying to ourselves. But the reality is is we have to understand that you won't make a lot of money in the stock market fast, and that's perfectly okay.
Jacob:That isn't the goal. The goal is not to make money right away because if we were to do that, we'd have to take really large amounts of risks. So an example of that might be, hey, I'm gonna sell the house and I'm gonna put all of my money into a new clothing company that I'm gonna start. That company could be worth millions of dollars in a couple years, but you had to give up everything you owned in order to take that chance to get there. There is risk in that, but for that risk, the reward should be greater.
Jacob:So the stock market is not that way. You cannot turn a small sum of money into a large sum very quickly. The power of the stock market is time. Think about it. The longer you invest, the longer your dollars will be compounding and growing for you.
Jacob:So time eliminates the risk of losing money because the longer you do it, those ups and those downs become smaller and smaller, and the market is continuously increasing over the long run, regardless of the current downturn that we face today. The second point I wanted to make in terms of becoming a wiser investor or eliminating the short term risks of investing is we have to have an automatic investment plan. So most of us fear volatility, but volatility in my opinion is something that we should view as a gift while you're accumulating and saving for retirement. So if you're three years or more from retirement, you should, in my opinion, be paying zero attention to stock markets or whether or not they're up or down because it doesn't matter to you. In fact, you should hope that the markets are down because if they stay down longer, well, you're gonna be buying and investing more at a lower price, meaning you're gonna be buying investments on sale.
Jacob:So we have to accept that volatility is the efficient relationship between temporary declines and larger permanent advances. I'm gonna say that again. We have to accept that volatility is simply the relationship between larger temporary declines and larger permanent advancements. So how do we create this automatic investing plan? Well, the the technical term for it is what's called dollar cost averaging.
Jacob:And it's one of the most underappreciated ways to build wealth, especially in today's world. We're taught to do all these flashy, cool things that very few people are actually able to execute on and make money doing. Dollar cost averaging has lost its appeal over time because it's just not as cool or flashy as the next new thing that's coming out. So dollar cost averaging is an autopilot way of building wealth. Well, what is it?
Jacob:Dollar cost averaging is simply buying every single month, every single week, every single paycheck, whatever it is, you're buying more shares of your investments regardless of the price that they're being sold at that day. So for example, if I was going to this month, I'm gonna buy my S and P 500 fund and it costs a $100 to share. And the next month, I'm gonna buy the same S and P 500 fund, but now it costs $90 a share. Well, the average of those two purchases comes out to $95 So it's an efficient way to get prices over time by investing and saying, I'm not gonna try to time the market by getting in today or waiting to some point in the future. What I'm doing is I'm gonna buy it today regardless of the price.
Jacob:And then next month, I'm gonna buy it again regardless of the price. I'm gonna do that year after year until I get close to retirement. And then at that point, I have efficiently saved and invested in such a way that I get the most optimal outcome. So it takes all of the different questions out of your control. When do I buy?
Jacob:When do I sell? What if I pick wrong? By dollar cost averaging, you avoid all those questions and the time tested principle of just keep buying, it works in your favor. So if you're dollar cost averaging, you're always winning. Think of it that way.
Jacob:When the market is down, you're buying more shares on a big sale. When the market is going up, you're staying disciplined and you're still accumulating shares. So when one thing is happening, the market's going down, you're getting more shares at a discount, which is great. We all love sales at the store when we go. And then when the market is going up and it seems like valuations are elevated, you're still staying disciplined and still purchasing new shares and still accumulating as you continue to prepare for your retirement.
Jacob:So, number two, create a dollar cost averaging plan and stick to it. Now, what is dollar cost averaging? Well, if you have a 403B or 401 k your hospital plan or wherever you're working, if you're simply automatically taking money out of your paycheck and sending it to that employer retirement plan every single month, that is dollar cost averaging. Maybe you can add to that in different accounts like Roths or taxable investment accounts or different IRA accounts outside of your four zero one k plan. But what you're doing is truly dollar cost averaging.
Jacob:You're doing it every single month or every single paycheck. You're buying new shares at the current price, whatever that price is. You're avoiding market timing. You're avoiding trying to pick which things to buy and when to buy them, and so dollar cost averaging is working in your favor. The main thing is make sure you're sticking to it.
Jacob:Even if you have to start small and increase it over time, the goal is not so much how much you're saving immediately, it is building in the behavior of continuous saving. That's the goal. And the third thing I'd like to say about becoming a wiser or smarter investor is simply just remember what the real risk is. Remember that people greatly overestimate the long term risk of owning stocks. And second, people seriously underestimate the long term risk of not owning stocks.
Jacob:So real risk is not volatility. Remember volatility is our friend as investors, especially whenever we're dollar cost averaging. The real risk of stocks is not owning them. Your greatest long term risk is not losing all of your money in the stock market. Your greatest risk is the erosion of your purchasing power like I mentioned earlier.
Jacob:We've seen this everywhere over the last couple of years as inflation has kicked in and things just simply cost more. Everything we buy costs substantially more than it did five years ago. So that's the risk that you're fighting against. And the way to do that is by investing in stock markets. So if you're 50 right now, and you are gonna be 81 day, well, we have thirty years to continue fighting against inflation so that your money does not become worthless.
Jacob:And stocks are the way to do that because stocks increase in value over time, and this is what we need to fight against that inflation. So remember that temporary market declines are necessary for the long term permanent increases. You can't have one without the other. The short term risk lends itself and leads to the permanent increases in the future. So if you can master this mental hurdle, you're gonna be better off than 95% of all other investors out there.
Jacob:So I'm just gonna wrap this up by reminding you that optimism is the only realism. And I encourage you to establish an automatic investing system like dollar cost averaging, and then separate yourself from the day to day craziness of the stock market. Your discipline and ability to control what you can control are your superpowers when it comes to investing. So I hope this has been an encouragement for you. And as always, if you have questions about investing or retirement, please reach out to me.
Jacob:My email once again is Jacob.Duke@AppliedCapital.com, and I'm happy to answer any questions that you have there. Once again, this has been another episode of Retirement Answers. My name is Jacob Duke. I look forward to talking with you again next week.
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