over 2 years ago • 4 mins
Everyone says there’s no such thing as a free lunch, especially when you invest in the stock market. But there is one almost guaranteed way to make sure you never make a loss – as long as you’re willing to be very hands-off.
If you’ve been in the investing game long enough, you’ll know that stocks can go down a lot.
In fact, buy-and-hold investors of US shares would’ve had to stomach losses of more than 40% five times in the past century – including 80% in the Great Recession of 1929. Take a look…
But stocks’ riskiness is also their silver lining: they go up in the long term precisely because investors can lose a lot of money in the short term. That makes sense: no one would invest in something risky if they could make the same returns with something safe, like depositing money at the bank.
Investors are profit-driven and need to be compensated for taking risks, in the same way a casino needs to be compensated for the risk of having to make a big payout. Over one game, the odds are only slightly tilted in favour of the casino (known as the “house edge”). But played multiple times, the casino will almost be guaranteed to make a profit…
Here’s the thing: the longer your investment horizon, the less likely you are to end up with a loss.
In fact, the probability of losing money decreases quite spectacularly with time. Invest in stocks for a day, and the probability you lose isn’t much less than the probability of losing a coin toss. Invest for a month and those 50/50 odds decrease to about 40%. If you held US stocks for 10 years, you’d have historically ended up with a loss only 10% of the time. And if you held for 18 years, you’d never have ended up with a loss.
The opportunity here is pretty clear: buy stocks today, go to sleep, and wake up in 20 years, with the near certainty of having made money while you slept. You might even have earned back that compensation for holding risky stocks – which has historically been 6.6% per annum (adjusting for inflation) over the past 121 years.
At a minimum, there are three important facts you should know:
Hold stocks for a few months and you’d have to be pretty unlucky to experience a 50% loss. But hold it for 50 years and it becomes a near certainty. And when that happens, it’s hard not to do something hasty – like selling at the bottom and turning those paper losses into a reality.
You have to hold stocks for more than 12 years to really reduce the probability of making a loss – and 12 years is a really long time in such a fast-paced world. Even in a 10-year period – which most of us would already consider long term – you’re not guaranteed to make a profit. And what’s more, the difference between success and failure is pretty significant. In other words, the return you’ll make over anything less than the very long-term is still highly uncertain. It depends on many other factors too, including things like starting valuations (which don’t look very promising right now). So unless you hold stocks for the next 20 to 80 years, it’s unlikely you’ll experience the typical 6.6% “average return” stocks have delivered historically.
There are two reasons you’re warned against using the past to predict the future. First, non-overlapping data – which is required to reach a statistically significant conclusion – is quite limited. If you’re assessing a 20-year period, for example, there are only five to look at in the last century.
Second, investors can fall victim to “survivorship bias”, which is the tendency to use current winners as a representative sample. For instance, today’s largest and most liquid stock market is in the US, which is also the country with the longest dataset. It’s no coincidence that it’s also been the top performing economy over the period, and by quite a high margin. Other regions – Japan, say – look less promising, and show you’d have needed to hold stocks for more than 50 years to avoid a loss.
So yes, you can reduce the probability of loss by holding stocks for the very long-term. But it won’t be an easy ride, as you’ll have to stomach scary market crashes and bear markets that can last years. And even if you do manage to hold, there’s no guarantee you’ll achieve that long-term 6.6% return we’ve seen historically. Still, if you’re aware of the caveats and you’re a hands-off kind of investor, this could be right up your street.
Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.