Do stocks always go up?

💼 Is your portfolio simply the S&P 500?

Note: Past performance is not a guarantee or indication of future returns.³

Over the past 15 years, the US stock market has been in an unprecedented boom. The zero interest rate era, rise of the Mag 7, and the recent AI boom have all resulted in huge returns for US stock investors.

Many investors have developed a belief that markets always go up. And that passively investing in the S&P 500 is the best strategy for long-term investors.

The data however leads to a clear, yet surprisingly contrarian conclusion:

Stocks carry significant risk. Even over 30-year investing horizons, the risk is non-trivial.

Read on to learn more

📈 The “average” rate of return on US stocks

Based on the previous 97 years of data (1928-2024), US stocks are the clear winner compared to all major asset classes.

Source: Computed from Stern NYU (Ashwath Damodaran) online dataset^1,3

However, the “average” return can be highly misleading.

Most people assume they will get the “average” return of ~7% if they were to buy-and-hold the S&P 500 for a long enough period (say 20 years).

That is not true.

Most investors do not get the average return.

In a comprehensive study titled, “Stocks for the long run? Evidence from a broad selection of developed markets (Anarkulova et al)”² , the authors paint a more accurate and startling picture.

In this study, the authors analyzed 178 years of data from all developed markets. And simulated buying and holding a diversified basket of stocks for 30 years.

Their results:

1. There is a 12% chance that a diversified stock investor would lose relative to inflation.

2. Investors have less than a 50% chance of getting the “average return”.

Let that sink in.

1. There is a 1 in 10 chance that you could lose money even when investing for 30 years.

2. The chances of you getting at least the average stock return is less than a coin flip.

You don’t get the average return if you invest passively. You get what the market gives you, based on your luck.

🔑 Why does this happen?

2 key reasons

• Averages can be misleading. They tend to include outlier years that may skew the average.

• Stock markets can provide poor returns for significant periods of time. If you happen to be invested during those periods, your total returns will be poor (even over long holding periods).

📉 Bear Market Examples

The chart below shows major US bear markets and the number of years it took for the market to recover.

During the Great Depression, the market fell by a staggering 86%. And took 25 years to recover. For people whose life savings were invested in the market, this event was financially catastrophic.

A more recent example is the ‘Lost Decade’ - the period between 2000 - 2009. Investors that purchased in 2000 were still underwater 10 years later.

Note: Past performance is not a guarantee or indication of future returns.³

💡 Think about this …

If you are 40 - 50 years old, would a 10-year (or 25-year) period of negative returns be acceptable to you?

For most people in that age group, it would mean significant delays in their key financial milestones such as retirement. Or worse, inability to fund major life goals such as their kids’ college education.

Even if you are a 30 year old, the prospect of waiting for years to recover is not fun.

⚠️ How to think about risk in investing

In investing, past performance is not an indication of future returns.

As humans, we are subject to strong recency bias. We assume that the future will be somewhat similar to the recent past.

Strong bull markets (such as the ones we have seen in the last 15 years) lull investors into complacency. And feed the belief that stocks can only go up.

History has shown that time and again to not be true.

The economy moves in cycles. Periods of boom are often followed by periods of bust. And when that happens, it almost always catches people unprepared.

🤔 What should investors do?

It’s clear that stocks are a great vehicle for growing wealth. And they have a great track record to prove it.

However, investing all of your assets in stocks is akin to putting all your eggs in a single basket.

Strategic diversification with other asset classes can mitigate the downside risk of stocks. And provide resiliency during poor economic cycles.

In our previous edition, we explored how a properly diversified portfolio could beat the market over a 20 year period.

For more conservative investors, the permanent portfolio (covered in our first newsletter) is a great example of a robust strategy that can provide even stronger downside resiliency.

In our view, success in investing comes down to being patient & having a disciplined investing strategy - and avoiding the FOMO of all-stock portfolios.