- The stock market performed poorly in 2022.
- Since 1928, stocks have substantially outpaced other investment options.
- Buying when others are overly pessimistic can increase returns.
“Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays it,” -Albert Einstein.
Last year was the first time the stock market and the 10-year Treasury bond both declined by over 10%. The damage to portfolios was widespread, and enduring that drubbing was disheartening. Yet, there remains no better place to park your money long-term than in stocks.
Despite the Great Depression, many recessions, a World War, a pandemic, and many other challenging times, the average return of stocks trounce other options for your hard-earned money since 1928, according to NYU's Stern School of Business.
It’s not even close
Stocks returned 9.64%, on average, per year, resulting in a $100 investment growing to an astounding $624,534.55 since 1928. Corporate bonds finished a distance second, with $100 growing to $46,379.53. Indeed, while there have been many logical arguments over the decades to shun stocks, avoiding them would've hamstrung generational net worth significantly over the past 94 years.
The magic of compound interest (earning interest on your interest) is the reason behind stocks’ remarkable performance. Every additional percentage return made per year meant more dollars that could multiply decade after decade.
This power of compounding, called the eighth wonder of the world by Albert Einstein, isn’t lost on Real Money Pro’s Paul Price. He recently wrote:
“Choosing where to put your long-term money is the single most important financial decision you will ever make. Doing less than the best thing could cost you up to millions of dollars by the time you hit retirement age…When you see the facts there is just one obvious choice if you have a long-term investment horizon. Both stocks and bonds had a horrendous year in 2022. It hurts to see IRA balances go down even after putting new money to work. Over the course of life, though, down markets help equity returns by allowing for dollar cost averaging. Every bear market in American history has been just a prelude to the next favorable market [emphasis mine].”
Every bear market preceded new all-time highs for the stock market. So, could stocks no longer be the place to be in the coming decades? I suppose, but I’m not betting on it.
I’m not alone.
In Warren Buffett’s letter to Berkshire Hathaway investors in 2014, he wrote, "Indeed, who has ever benefited during the past 238 years by betting against America?”
Instead, it pays best to buy pessimism rather than sell it. That approach is a big reason Warren Buffett became one of the wealthiest people on the planet.
Buffett’s mentor Benjamin Graham once wrote, “The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is a realist who sells to optimists and buys from pessimists [emphasis mine].”
Sir John Templeton wrote, “the time of maximum pessimism is the best time to buy.”
Templeton was so convinced that on the cusp of World War II, he purchased $100 worth of every publicly traded stock trading below $1 in 1939. That decision resulted in a 400% return over the next four years. Talk about buying pessimism!
Given returns like that, it’s little wonder famed investor Shelby Davis once wrote, “You make most of your money in a bear market, you just don't realize it at the time.”
These legendary investors knew that stock market returns move up and to the right over time, but they don’t do so in a straight line. The most money can be made when stocks appear to be a horrible investment rather than an easy path to riches.
For example, the average first-year return for the S&P 500 in a new bull market is 38%, according to CFRA. That’s miles better than the average return in a typical year.
The stock market’s long-term resiliency means consistently investing, including during lousy performing years, can create life-changing wealth.
Back to Price:
“Now that I have shown the futility and wrongheadedness of owning anything but equities in your retirement account, let us look at how easy it will be to become a millionaire. Even a paltry, by historical standards, 5.5% average return on stocks would turn annual $6,500 Roth IRA contributions into $1,003,156 from age 25 to age 65. Achieving the average S&P return of 9.64% would morph your $260,000 cumulative contributions into a solid $3,118,223. Dream big, make a few great decisions, and you could end up with almost $7 million even without using the extra "catch-up" contribution limits allowed by law after age 50. Playing Power Ball lotteries is not a good substitute for true retirement planning. The trick to achieving long-term wealth is realizing that "get rich slow" is the way to go [emphasis mine].”
The Smart Play
There’s no shortage of reasons for pessimism. The Federal Reserve’s drumbeat remains higher rates for longer, and higher rates, as we’ve discussed many times, devalue forward cash flows, causing valuation multiples to retreat. The hawkish Central Bank policy has significantly increased the odds of a recession, bad news for corporate earnings, and the risk of rising unemployment remains an overhang.
Yet, the stock market is higher now than six months ago. Indeed, stocks could fall again. But the media headlines screaming “fear” completely discount that most major sectors and indexes have produced positive returns for investors since the middle of 2022. Would you have guessed that to be true, given the headlines you’ve read?
In reality, individual stocks bottom before the stock market, and the market bottoms before the economy. Remember, stocks usually bottom before unemployment peaks, when corporate earnings look terrible, and when there’s little evidence for optimism.
Historically, it pays to sell the first half of the bear market and buy the second half of it. Unfortunately, nobody rings a bell, signaling half-time. As a result, hoping to buy the exact low is, at best, educated gambling. Instead, investors should focus the bulk of their financial strategy on dollar-cost averaging into a market index through thick and, especially, thin.
This approach results in buying more shares at lower prices during a bear market, allowing investors to more quickly recapture prior peak account values during the next bull market. So, the next time you read a scary headline about dismal returns, know that, like legendary investors past, you’re taking full advantage of widespread pessimism.