One principle of investing that we constantly reiterate because we believe it is so foundational is the concept of keeping a long term mindset in the capital markets. This is especially difficult in today's world that is rife with instant transmission of information and fast money strategies revolving around SPACs, Crypto, and reddit “meme” stocks. In fact it almost feels inhuman to be indifferent to the constant hurling of strong opinions easily transmitted through social media and instead see the big picture. But history has proven time and time again that the most effective strategy to growing wealth is to purchase shares of strong businesses at reasonable prices and then simply let time and compound interest do its work. Most American fortunes were earned via ownership of strong businesses for many years.
Not only does time allow stocks to execute their compounding nature but it also lowers the risk level thus helping to avoid losses. The probability of losing money on stocks over a one day period is a little worse than a coin flip (46%), but the probability declines to just 6% over a 10-year window since 1929. In fact, negative 10 year returns are very rare. Outside of the 1930s, the 2000s were the only decade with negative total returns.
Timing the market effectively is incredibly difficult and many would say impossible over the long term. Since the 1930s, if you sat out the 10 best return days per decade, your return would be just 28% compared to staying invested and earning a total return of > 17,000%. This is because the S&P 500s best days generally follow its worst days when sentiment is at its trough and securities are most mispriced. But remaining invested during turbulent times is also the best way to help recover losses. On average it has taken about 1,100 trading days to recover losses after a bear market. Some recoveries, like last year happen much faster. But if you miss out on those highest return days near the bottom it will take longer to claw back those losses.
Interestingly, these long term characteristics are not shared by other asset classes such as commodities. Since 1929, instances of 10 year negative returns for commodities (based on WTI Oil) have been closer to 30%. This can be attributed to possibly a mixture of reasons but is a good illustration as to why equities are the preferred long term investment vehicle. Stocks represent ownership stakes in companies which are made up of dynamic people and assets which produce goods & services. Combined with a historical earnings growth rate of 6% driven by consumption, inflation or the ability to raise prices, and demographic tailwinds, creates an ability to forecast returns. Commodities on the other hand are simply static goods that have value, but are not constantly adapting, solving problems, and internally compounding their value.
In our note late last year ‘The Armageddonists’ we addressed the psychological side of why many of the apocalyptic media headlines revolving around the stock market and economy were to be taken with a grain of salt when making long term investment decisions. This note supplies perhaps some of the math that reinforces that philosophy.
And just like with our Armageddonist note, all of this is not to say that market volatility will not arise and that market movements are to be ignored. But it is to prepare for these periods and not lose the forest for the trees.
Commentary Disclosures: Covington Investment Advisors, Inc. prepared this material for informational purposes only and is not an offer or solicitation to buy or sell. The information provided is for general guidance and is not a personal recommendation for any particular investor or client and does not take into account the financial, investment or other objectives or needs of a particular investor or client. Clients and investors should consider other factors in making their investment decision while taking into account the current market environment.
Covington Investment Advisors, Inc. uses reasonable efforts to obtain information from sources which it believes to be reliable. Any comments and opinions made in this correspondence are subject to change without notice. Past performance is no indication of future results.