I like charts — it’s fascinating how a quick illustration can help people explain and understand complicated concepts in a digestible manner. There is one chart that rises to the top of my list when I’m speaking to or working with clients, particularly those who are concerned about market volatility.
In my opinion, the chart above successfully conveys five of the most important principles you should know if you decide to invest in the financial markets:
1. Markets go up over time.
Sure, everyone “knows” that markets go up over time — but this chart paints a bigger picture of just how much they can rise over the course of a few decades. Since 1970, the value of a dollar in the world stock market has increased to $59, as of December 31, 2017. Over a longer period of time, the S&P 500 has had an average annual return of roughly 12%. 1
“Time” is a critical caveat, meaning the more time you have to invest, the more you can allocate to stocks in your portfolio and live through the ups and downs. But, in any time frame, you must have the discipline to stick with investing and allow the markets to work for you in order to reap strong rewards.
Studies indicate that many investors’ portfolios underperform because they fall prey to making poor decisions, such as attempting to time the market. Why do markets continue to go up? It’s because capitalism and innovation work to grow world economies, and because billions of people around the world want to improve their standard of living.
Companies like Amazon, Google, Apple and Facebook dominated the stock market in 2017, but they didn’t even exist in 1970. New industries like 3D printing, artificial intelligence (AI) and others we can’t even imagine today will likely contribute to continued growth moving forward. If you believe in the power of people and innovation, there is no reason to think that similar growth in the stock market won’t continue indefinitely.
2. It’s not a smooth ride — but so what?
See Lesson #1: We receive a significantly higher return than cash for being in the stock markets and dealing with the uncertainty of returns from year to year. Day-to-day and week-to-week market movements just don’t matter. Say it again with me, as you look at the chart above — they just don’t matter!
If you look at the chart closely, you’ll notice many negative return periods, including short-term corrections and even very painful, longer bear markets. But seeing what happened in the periods following those negative returns should calm your fears and reinforce your belief that markets eventually recover from low points and start generating positive returns again. If you are truly investing for the future, the current fluctuations just don’t matter. On the other hand, if you are investing for the short term, then you should be in a much more conservative allocation, or you should not be in the stock market at all.
3. Bad things happen around the world all the time.
Overlaying major global events on to a line graph of world stock market returns helps us reflect on some of the difficult financial events that have occurred over the past few decades — wars, financial crises, high inflation and significant bear markets, among others.
When those events occurred, the markets often reacted negatively in the short term — sometimes significantly, as one would expect. Yet, markets eventually recovered and proceeded to reach new highs. While the stock market often reacts adversely to events in the short term, investors soon recognize the fundamental value of the companies that make up the stock market. If you don’t panic or try to time the markets, you’ll be well-positioned to weather the storms over the long term.
4. The majority of bad things that happen are not predictable.
No one could have predicted most of the events listed on the chart, nor could they have predicted the scope of severity and the degree to which markets would react (be careful of hindsight bias in thinking, “I knew it was going to be bad!”).
Many investors fall into the trap of worrying about “bad” things happening somewhere in the world or believing there is something detrimental on the horizon. Ultimately, stock markets are made up of billions of people (plus or minus a few) who are investing for different reasons and at different times. When you invest, the prices of companies combine to provide the aggregate of the stock market, which reflects all of the fears and concerns of the people participating. No one can consistently and accurately predict world events or how markets will respond — but as the chart reflects, investors who don’t panic or try to time them will fare better than those who do.
5. The economic and market information we are swamped with doesn’t matter.
Every day, we are bombarded with the latest economic and market news on topics like interest rates, inflation, bond yields and home sales. While they can help investors understand economic trends and data that affect markets in the short term, these news updates are mostly noise.
The chart reflects how stocks have continued to generate positive returns over time through all types of economic cycles, including high inflation, high interest rates, low inflation, low interest rates and whatever the concern of the day may be. If you are confident in the power of the markets and their ability to weather all types of cycles, which this chart reflects, then you should ignore this noise. Over the long term, it won’t provide you with any meaningful or actionable information. In fact, you are more likely to make investing mistakes by overreacting to this type of information — and that includes the often-dramatic talking heads on cable television who are trying to attract viewers.
This chart reflects nearly 50 years of market performance, which is about the same length of time that many adults invest during their lifetimes. Investors are often advised to “stick with the plan” and ignore short-term noise with the knowledge that markets go up over time. Hopefully, by seeing evidence of this growth in the chart above, you will find considerable confidence and peace of mind in that advice.