The Price of Return

Virtually every investor in the stock market knows that investments can be risky. But how risky are they, and what exactly does "risk" mean on the stock exchanges? Opinions on how risk is defined differ. We like the definition by Elroy Dimson, a famous economist: "Risk means more things can happen than will happen." Human behavior is very strongly influenced by emotions, and this is no different on the stock exchanges. Just as stock prices can overshoot during rising stock markets, they can also undershoot during poor phases. Of course, falling stock prices are extremely unpleasant, but they also repeatedly offer entry opportunities for long-term investors. In summary, a stock investor should be amply rewarded in the long run for the risk they expose themselves to. In the past, this has always been the case, and we believe this will not change in the future. The following 5 facts should help investors withstand stock market fluctuations without losing sleep:

1. Identifying major price losses (market timing) is impossible

We would all like to be able to time the markets to avoid losses. History and data suggest to us that this is nearly impossible. If it were possible to identify these market drops and thus only be invested during rising stock markets, one would very quickly become one of the richest people in the world. Unfortunately, investors must go through the tedious market drops of the stock market to be amply rewarded over the long term.

2. Even professionals cannot avoid market drops

In the past, stock markets have undergone periods of large price losses more frequently than investors might think. If you assume that only amateurs cannot avoid market drops, you are mistaken. Two facts on this: (1) Even with the most successful long-term managers, there are major setbacks. (2) There is no correlation between a manager's long-term performance and the extent of their largest performance drops.

3. Losses are inevitable (but not in the long run)

Going back in history to 1900, you can immediately see that stock markets can be incredibly volatile over a one-year period. Drops of 10% to 30% are relatively common. However, over a 5-year period, decreases become much rarer. With a holding period of 10 years, they are practically non-existent, and over 20 years there are no periods with negative returns. Conclusion: The longer the holding period, the greater the probability of a positive return.

4. Even Warren Buffett cannot escape volatility

Many of us would like to permanently achieve an annual return of 20% without the value of the investment ever decreasing. The only ones who succeed in this are the Bernie Madoffs of this world, because they are eventually exposed as fraudsters and hopefully end up in prison!

Berkshire Hathaway (Warren Buffett's investment vehicle) recorded four years in which it fell by more than 20% and six years in which it underperformed the S&P500 by more than 20%.

5. Stocks reward investors very well in the long run

So if you have endured these occasional 50% setbacks and the more frequent 20% corrections, you should be amply rewarded, as mentioned. But how amply? An investment of $100 in the US stock market in 1899 would have grown to $9,994,326 today! Hard to believe, but true! The short-term risk of stocks has therefore been more than amply rewarded in the long run.