The Best Investment You Are Likely To Ever Make - But Only If...

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About: Vanguard 500 Index Fund Inv (VFINX)
by: Tom Madell
Summary

Down through history, stocks have been one of the best investments for accumulating wealth, but only if viewed from a long-term perspective.

But fund/ETF investors are often fearful of being invested at market highs, so they often either don't invest or pull back.

So how does that affect their ability to accumulate wealth?

My research shows that even if one invests "at the worst possible moment," stocks as measured by the S&P 500, are still likely to be profitable after 3 years elapse.

Investors who fail to realize stocks exponential long-term potential will most likely miss out on the outsized gains possible.

Fear is a four letter word for most fund/ETF investors. While a certain amount of caution is always in order, fear of investing, especially at what you might envision will turn out to be the absolute worst time, may wind up costing you big time. This can readily turn out to be the case if you fail to consider the long-term picture and aren't able see yourself as willing, or, of the temperament to commit to a long-term journey when investing in stocks.

Today's stock market easily qualifies as just such a moment. With stock prices near record highs, it might seem to many that this too is one of those moments where prices have reached almost dizzying levels. For the investor out, or nearly out, of the market, it would seem far too late (i.e., dangerous) to get involved. And for the investor already committed to a position, common sense (and at least a little bit of fear) might seem to dictate "taking some money off the table." Likewise, adding to your position at this point, even through continued, regular 401(k) contributions might seem equally unwise.

Of course, investors have witnessed this many times before, both recently, and down through the years. So it becomes reasonable to ask the following question: How wise did it prove to be to have acted on these fears?

For the relatively rare investor who feels fortunate enough to have already achieved a solid nest egg, thanks largely to his investments, but who does not want to risk slipping back from such a comfortable position, reducing or eliminating a stock position while ahead of the game cannot be faulted. But for the more mainstream investor attempting to continually accumulate wealth gradually and willing to put up with the market's at times severe ups and downs in order to achieve that end, such a move may run counter to his long-term objectives.

Hence, a common fear of many investors (or would-be ones) seems to be that of putting new money into stocks, or even to just holding what you already have invested, at what turns out to be a market "top." At such instances, the worrier's assumption would be that stocks are likely primed for a fall and the investor who chooses not to act to protect himself, or conversely, just continues as usual, will wind up regretting his choice.

So, is there realistically a "worst" possible moment to put new money into stocks, or to decide to just to continue to hold them without taking action to avoid losses? Maybe, but such will be impossible for anyone to know in advance. At any given time, regardless of stocks current levels, stocks could embark on a steep drop, or continue to go up much higher on a path that few would have anticipated. In fact, all market participants must be willing to accept this reality from the day they enter the market to the day they leave; unfortunately, this unknowability is always just a part of stock investing. (But on the other side of the coin, the market goes up in the long term far more often than in goes down, greatly improving one's chances of success, as one will be reminded of shortly.)

It sometimes seems so logical to make assumptions about the market's upcoming direction but your chances of navigating potential ups and downs are likely to be no more accurate than flipping a coin. (In fact, due to the fact that market moves are often counterintuitive (i.e., opposite) to what most people expect, you are more likely to be wrong in your guess as to the market's next move than to get it right.) In other words, in order to be correct, one would have to a remarkable ability to correctly "time" the market, something that virtually all market experts agree is nearly impossible.

Getting back to the fear of buying or holding stocks at the worst possible moment, even assuming such a moment could be identified, this remains a near-paralyzing force for many fund/ETF investors, as well as would-be investors. But what are the facts when it comes to investing at the so-called "worst" possible time?

In order to find out, we can go back a number of years to see what would have happened had an investor been unwise or unlucky enough to have bought stocks on the very day before the market wound up entering a bear market, or just a 10%+ correction. Would that mean that for years to come, he might not only fail to make a profit, but worse, be doomed to suffering a loss on the value of the investment as of that particular unfortunately chosen day?

Of course, such an analysis relies totally on what the market did in the past. In the real world, any outcome is possible, regardless of what might have happened in prior years. But the past offers much guidance as to what is most likely to happen in the future, especially when it, so often, and for so many years, has shown an unmistakable path.

In this regard, I am reminded of another example that seems in some ways relevant to how investors should think about this. In 1980, the median home price in the U.S. was about $47,000, and by 2000, nearly $120,000 (see here for how much housing prices have skyrocketed over the last 50 years); today (as of this July), it is $218,000. (Obviously, the price rises have been much more extreme in many cities such as San Francisco or New York to name just a few.) Thus, in spite of occasional, and sometimes big dips in housing prices, no matter when you bought a house, you usually profited from the long-term trend of a rising market. While not all home purchases will always be profitable, the general trend over many, many years has been up for prices to continue to go up.

History shows that in the case of both stocks and houses, prices have risen exponentially. Regarding housing, generally, whenever an asset such as a single-family home has been much in demand, with available supply somewhat unable to keep up, prices have tended to appreciate above and beyond normal inflation. But back in 1980, who would have thought that by buying a house, you would not only be making a good investment but one that might increase in value in very large multiples?

Since most people would have been unlikely to expect such continued outsized price appreciation, it is easy to imagine that many would have been cautious buying into a housing market that already appeared overextended. But those who bought simply because they needed a home for the years ahead, and disregarded the possibility of short-term price drops, turned out to have likely made a wiser decision than those who constantly put off making a purchase on the assumption that prices were already too high to be sustained, or for fear of making a losing investment.

So, too, with stocks, it has been common to fear what might lie ahead in the relatively short-term and ignore the long-term wealth-generating propensity of stock ownership. It is important to know the history of stock prices to realize just how profitable long-term ownership has been in spite of the ever-present threat of shorter-term price drops.

In the chart that follows that goes back almost 40 years, I list every occasion in which the S&P 500 Index dropped at least 10% from a previous high, followed by what wound up to be actual performance results exactly 3 years later of the Vanguard 500 Index Fund (VFINX) which very closely mirrors the S&P 500. (Note: I picked the S&P 500 Index and the Vanguard 500 Index Fund because both have been around for a long, long time. However, other indexes and funds could have been chosen as well.)

Date Preceding
Drop

Amount of Drop

Gain/Loss
3 Yrs Later
(not annualized)

10/5/79

10.2%

29.1%

02/13/80

17.1

45.1

11/28/80

27.1

36.0

10/10/83

14.4

54.8

8/25/87

33.5

2.8

10/9/89

10.2

23.2

10/7/97

10.8

50.9

7/17/98

19.3

6.6

7/16/99

12.1

-33.7

3/24/00

49.1

-41.0

11/27/02

14.7

45.9

10/9/07

56.8

-19.8

4/23/10

16.0

38.7

4/29/11

19.4

46.7

5/21/15

14.2

36.3

1/26/18

10.2

3.2 (see Note 5.)

Notes:

  • Not all lists showing "corrections" or "bear markets" agree since they may have slightly different definitions of each.
  • Ten percent or more corrections are as shown here.
  • Bear markets are listed here.
  • Cumulative returns were determined by using the "Growth of 10K" feature at Morningstar. They include reinvested dividends.
  • As of 9/4/18.

As you can see, buying or holding the Vanguard 500 Index Fund (VFINX) even on the "worst" day (i.e., right before an ensuing drop) still turned out to be profitable by three years later in 12 out of 15 cases. The average gain when held over the following three years was 21.4% (not annualized).

While three years is usually sufficient to wipe out periods of poor stock market performance, in some cases it will be necessary to hold on somewhat longer. That is why it is wise to consider keeping any money you have in the stock market there for at least 5 years going forward. If you cannot envision doing that, you might want to evaluate whether you could withstand possibly being less well off financially at that time than you are at present in terms of your total accumulation but this is likely a worst case scenario, although still possible. Of course, most people do not have the misfortune of buying on the absolute worse day before a big drop so the "real world" table figures for most investors would be likely to better than shown.

On the other hand, if one had held the above investment from the date of the first 10%+ drop in the above list (10/5/1979, approaching 40 years ago), an investment of $10,000 would have grown to just shy of $700,000! Based on what financial experts have preached for many years, and borne out by historical data going well back over more than even the near-40 years presented, just as with single-family housing, investing in stocks is probably your best chance of accumulating wealth over the long term. But one has to have a long-term mindset, something that is commonly not appreciated enough by people as they think about their long-term goals.

Disclosure: I am/we are long VFINX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.