Is the stock market risky?
Newspapers are full of stories bracing you for bad weather ahead, that’s how they sell papers. But before you believe what you read, remember one thing – it is very difficult to predict the future, even for very smart people.
Warren Buffett, the world’s most successful investor says, “The only value of stock market forecasters is to make fortune tellers look good.” And while we mean no disrespect to those who try, a lot of the time they do get it wrong.
Had you heeded the warnings sounded by Barron’s magazine saying it’s time to brace for a 20% correction in December 2013, or Société Générale saying the market was due for an imminent 75% fall in January 2016, then you would have missed out on the ensuing gains. As Warren Buffett says, “trying to time the market is the number one mistake to avoid”, and that’s because it’s very hard to get right.
The short-term vs long-term
What the graph above illustrates is that in the short-term the stock market can be volatile (meaning the share price fluctuates a lot). And when this happens you can be sure the front pages of the papers are inundated with negative headlines. This can make investing feel uncomfortable and risky but it’s important to keep it all in perspective. These setbacks only become losses if you sell your shares before they’ve had a chance to recover. While past performance is no guarantee of future performance, if you look back at history, these headline-grabbing moments don’t look so bad, do they? You wouldn’t want to miss out on those long-term gains because you stepped out at the wrong time.
Corrections and crashes will happen
If you understand that corrections and crashes are going to happen, then you’re prepared, and you know what you expect. They have happened throughout history and despite this, the stock market has been the best place for the longer-term investor to grow their wealth. You just need to understand the risks, then manage yourself, stick with your plan and keep a lid on your emotions.
What you need to know about corrections:
- They’re a 10-20% fall in the stock market
- They happen once a year on average
- The average fall is 13.5%
- And the average duration is 54 days
What you need to know about a crash (also called a bear market):
- They’re a stock market fall of more than 20%
- They happen on average once every four years
- The average fall is 33%
- And the average duration is one year
Don’t forget, 80% of corrections do not turn into crashes. And while we can’t predict the future, so far 100% of crashes have been followed by a recovery that more than recovers the fall.
Your secret weapon
While people see risk as a reason not to invest, your secret weapon in managing this is time. The longer you leave your money invested, the higher the probability of it performing better than cash. Here’s a graph that shows the percentage of times during the last 116 years that shares have beaten cash when held for five, 10 and 18 consecutive years.**
Tune out of the short-term market fluctuations as much as you can. Know your time horizon– and if you’re investing for the longer-term (more than five years) then you can ride out the shorter-term highs and lows. Over the last 20 years, the FTSE All-World GBP has averaged an annual return of 7.9%. And volatility is just the price you pay for these higher long-term returns. The risk becomes less risky with time, the key is to not invest money that you may need to access in the short-term (like emergency funds or other expected costs over a five-year period).
Today is the best day to invest in stocks – because the sooner you start, the sooner you’ll start benefitting. As you’ll see, the longer you’re invested, the higher the probability of you getting greater returns.
It is also important to remember that past performance is no guide to the future and all investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest.
** Source: Equity Gilt Study 2015.