Broker Check

Investing In One Chart

March 29, 2017
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If I could use only one chart to explain investing, this would probably be it.  Let’s consider, in just a few words, all that these five squiggly lines and labels tell us.

First, to get ahead with investing, you not only have to earn a return, you need a return that exceeds the rate of inflation (CPI).  Over the last 89 years, inflation has compounded at 3% a year; you needed $14 in 2016 to buy what only took $1 in 1928.  Another way to say this is if you had $1 in 1928, its “purchasing power” was only $0.07 today.

Second, there is a very clear relationship between short-term risk (volatility and losses) and long-term returns.  Five-year bonds experienced minimal risk but barely outpaced inflation.  $1 only grew to $87.  Through the early 1980s, they only matched inflation (50+ years with no return in excess of inflation).  Large cap stocks, in comparison, were much more volatile and had much higher long-term returns.  $1 grew to $3,175 over this period due to about 4% per year higher returns than bonds (+9.5% vs. +5.2%).

Third, while important, the stock/bond ratio isn’t the only decision investors should consider.  Shares of lower-priced value and smaller cap stocks are more volatile than traditional large-cap stocks, and the reward for that risk was even higher returns.  US large value stocks produced +11.3% a year, and US small value stocks did +13.5% per year.  Due to the power of compound interest, that propelled $1 to $13,591 and $78,639 respectively.  Little differences in return add up over time.

Finally, let’s consider the trajectory of these returns.  There are no permanent setbacks.  Even the Great Depression (1929-1932) at the beginning of the period was history within a few years.  1973-1974?  2000-2002?  2008?  For diversified stock portfolios, these are all just unfortunate but unavoidable blips on a path that marches ever higher over time.  There is a significant reward for the investor who can sit patiently through these setbacks. Investors who cannot often pay a steep price in the form of missed-out-on returns or a loss of their purchasing power.

If you would like a second opinion about your investment plan, or greater clarification about how these long-term asset class relationships can be applied to help you achieve your financial goals, don't hesitate to contact us.  We are happy to discuss your financial situation with you further.

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Past performance is not a guarantee of future results. Indexes include the reinvestment of dividends but not additional real-world costs such as expense ratios or advisory fees. This content is provided for information purposes only and should not be considered a recommendation or endorsement of any particular security, strategy, or service.