The S&P 500 since 1950 has fallen 47% of the time on a daily basis. That means that chance of the market rising or falling each day is a shade better than a coin toss. However, the market falls only 27% of the time on a 12 month, and only 7% of the time when you look at a rolling 10 year view. From a historical standpoint the chance of market decline reduce significantly as your time horizon lengthens. On a daily basis, all of us are really guessing as to how the market will do. Nonetheless, over the course of a decade, it’s surprising if stocks don’t rise in value.
What looks almost random on a day to day basis, then becomes a relatively reliable upward movement the more you zoom out in your time horizon. It turns out that the “almost” matters a great deal over time. The apparently small +6% bias to upward movement each day adds up to significant gains over the longer term. This is true even though the upward and downward movements are roughly equal in size +0.65% and -0.67% down on a daily average. To paraphrase the Hunger Games, the odds are ever in your favor, and over time those minute differences in the odds really add up.
On any given trading day, your expected return is a miniscule +0.039%, but over 251 trading days that same daily gain becomes +10.3% and over 30 years it becomes a staggering +1684% return. Compounding is a powerful force when you have it on your side. Of course, those are numbers based on historical data, but there is reason to believe that historical market analysis can be insightful in estimating future returns.
That’s one of the reasons why at FutureAdvisor we’re comfortably with relatively high equity exposure within client portfolios. Stocks are risky on a day to day basis, and indeed falls of almost 40% in a single year are not unheard of. The market is not the place to put money you’ll absolutely need within a decade. However, if you have a long-term time horizon the risk is greatly reduced because there’s no need to predict the market on a day-to-day basis. You’re predicting where it will be on a 10 year view and that’s a relatively easier time period to have some confidence that stocks will do well.
Furthermore, even if things don’t work out as planned we employ a 12 asset allocation structure with rebalancing at FutureAdvisor. This means fixed income instruments in the portfolio likely offer some cushion if growth falls unexpectedly. Alternatively TIPS and REITs provide some potential buffer at time of rising inflation. Finally, layering on international diversification can further reduce risk.
So if you have money that you’re investing for the long term, such as retirement savings, investing in stocks can make sense. What appears risky on a daily basis is a lot less so if you have the luxury of time on your side.
The views expressed represent the opinion of the author and are not intended to reflect those of FutureAdvisor or serve as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell securities. Past performance is not indicative of future results.