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The Case for Investing—Year In, Year Out

By Carrie Schwab-Pomerantz
Key Points
  • Is market volatility keeping you on the sidelines? History and context make a strong case for investing in stocks, provided you maintain a long-term perspective.

  • Equities have historically outperformed other asset classes and also provided the best defense against inflation.

  • Diversifying your investments and staying invested long-term are essential for minimizing stock market risk.

Dear Readers, 

If you had an extra $2,000, would you invest it in the stock market today? Should you? These are two very different questions. But the answer to each has a lot to do with history—both the history of the person answering the question and the history of the market.

According to a 2018 BankRate survey30 percent of Millennials favor cash as a long-term investment while 33 percent of Gen Xers, 38 percent of Boomers and a whopping 44 percent of the Silent Generation favor stocks. It would seem that age and experience have something to do with investing attitudes. And that makes sense. Millennials have seen a lot of market volatility in their lifetimes, including the Great Recession. But older generations, who as a whole have invested in stocks over time and watched their money grow despite various economic upheavals, tend to have a different perspective.

Is it just personal experience driving these attitudes? I'd say no. The history of the market itself has a compelling story to tell that makes a very strong case for investing in stocks. You may have heard some of it before, but I think it's worth retelling. And if you're one of the many younger adults who have asked me if now's the time to get into the market, I hope you'll find new information—and inspiration.

Stocks have historically outperformed other asset classes

If you're looking at stock market performance, you're looking at numbers. And according to the numbers, equities have historically outperformed other asset classes and inflation.1 Not only historically, but significantly. Take the potential growth of a dollar invested in various financial instruments below from 1926 to 2017. In that 91-year period:

  • A dollar initially invested in cash investments would be worth $21.
  • That same dollar invested in bonds would be worth $101.
  • If that dollar were invested in large cap stocks, it would be worth $7,338.
  • An investment in small cap stocks would have turned that dollar into $22,997.

Think about all the world events during that time period—wars, depressions, social upheaval—you name it. And despite many and sometimes dramatic downturns, stocks historically outperformed over time.

And let's not forget about inflation. This same research showed that the inflation adjusted value of that 1926 dollar would be $14 in 2017.1 As you can see from the first bullet point above, if you kept it in cash investments during those years, you'd barely be beating inflation.

Waiting to get into the market could cost you

To me, these numbers speak pretty loudly. But there's even more to the story and it has to do with the concern about volatility. The recent market roller coaster can be scary and an investor would understandably be worried about getting into stocks at the wrong time. But again, let's look at history. Here are some more numbers looking at market scenarios also from 1926 to 2017 that may help put that concern in perspective.

The research looked at four different types of hypothetical investors with different attitudes towards stocks and timing.2 The hypothesis was that each invested $2,000 a year for 20 years for a total investment of $40,000.

  • Investor A had the best timing and invested in stocks every year at the market low (a practical near impossibility, but just for the sake of the example). The value of the investment after 20 years was $176,679.
  • Investor B decided to invest in stocks the 1st day of each year regardless of market conditions. The value after 20 years was $163,918.
  • Investor C, with poor timing, invested in stocks at the market high every year ending up with $142,012. While Investor C was not in the market, they stayed in cash investments.
  • Investor D didn't trust the stock market and stayed in cash investments. After 20 years, the value of the cash investment was $64,925.

Interestingly, results were true for every 20-year period between 1926 and 2017. As you can see, investors A, B and C faired quite well while investor D fell way behind. Which to me says that the most important thing is to get your money working, and the sooner the better. As the adage states, time in the market is more important than timing the market.

You can't predict—but you can help prepare

That doesn't mean you should just close your eyes and jump in. Investing does include risk, and downturns happen. So money you may need in the next three years—like a home down payment, vacation fund or emergency fund—shouldn't be invested in stocks.

However, money you can keep invested longer term has the potential to ride out market ups and downs and may benefit from growth over time. In other words, successful investing is not about ideal timing but more about exposure over the long-term.

So if, for instance, you're young and saving for retirement, it would be totally appropriate to invest in stocks. Needless to say, as you get closer to tapping into that retirement money, you'd want to gradually reduce your exposure to stocks. 

Diversification is the key—and it doesn't take a lot of money

Diversification is another key factor in reducing risk. While it's important to start investing, it's equally important not to invest in just one thing—the proverbial not putting all your eggs in one basket. Fortunately, stock mutual funds and exchange traded funds (ETFs) can make it easy to diversify with a relatively small investment.

Next up—how to get started

So now how would you answer my initial question? Would you decide to invest that $2,000? It doesn't have to be complicated. In next week's column I'll tell you how easy it is to get started with something you may already have working for you. Curious? Check back next week.
 

[1] Source: Schwab Center for Financial Research. The data points above illustrate the growth in value of $1.00 invested in various financial instruments on 12/31/1925 through 12/31/2017. Results assume reinvestment of dividends, capital gains, and coupons; and no taxes or transaction costs. Source: Morningstar, Inc. Based on the copyrighted works of Ibbotson and Sinquefield. All rights reserved. Used with permission. The indices representing each asset class are S&P 500® Index (large-cap stocks); CRSP 6-8 Index (small-cap stocks) through 1978, Russell 2000 thereafter; Ibbotson Intermediate U.S. Government Bond Index (bonds); and Ibbotson U.S. 30-day Treasury bills (cash investments). Past performance is no guarantee of future results.

[2] Source: Schwab Center for Financial Research. Stocks are represented by the S&P 500® Index with all dividends invested. Cash Investments are represented by the Citigroup U.S. 3-month Treasury Bill Index. Average results remained relatively unchanged when the study is extended to 12-month periods that begin with a month other than January. In the case of the 12-month period that goes from February to January, Investor B invested immediately on the first day of February each 12-month period for 20 years. Past performance is no indication of future results.

 

Have a personal finance question? Email us at askcarrie@schwab.com. Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries, contact Schwab.

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Indices are unmanaged do not incur fees or expenses, and cannot be invested in directly.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Small cap stocks are subject to greater volatility than those in other asset categories.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower rated securities are subject to greater credit risk, default risk, and liquidity risk.

Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

The Schwab Center for Financial Research is a division of Charles Schwab & Company, Inc.

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