If you're someone who's wary of investing in the stock market, or at the very least are distrustful of the long-term benefits of owning equities, this week's events probably only added to your skepticism.
After the Dow Jones industrial average plunged nearly 900 points in the past 48 hours, leaving the index down 5.8% for the week and more than 10% off its record close in May, you could almost see the little thought bubbles rise: "Is this the start of bigger troubles ahead?" . . . "How will that affect my 401(k) and my kid's college funds?" . . . And "why do I keep putting money into stocks?"
Even before the market's slide—the result of a Wall Street freakout over China's slowing economy and worries that the Federal Reserve could soon begin raising interest rates just as global growth is deteriorating—there were signs that investors hadn't fully bought in.
For instance, only a quarter of millennials own stocks, and merely 18% believe that investing in equities is the best way to save for the future. That's probably because Gen Y graduated into one of the worst economies in decades with a stock market collapse to boot. Plus, unprecedented levels of student loans may hinder their ability to invest.
But baby boomers also seem to be wary of stocks. Yet those nearing retirement will need a healthy portion of their portfolios in higher returning fare like stocks in order to avoid outliving their money.
That may be a tough message to hear after days like Friday. But it shouldn't. And here's why:
If you're someone who thinks investing in stocks is akin to gambling, name the casino where the player wins the vast majority of the time. "Since 1947, the S&P 500's price return was up in 72% of calendar years," S&P Capital IQ equity strategist Sam Stovall recently noted. "Add in dividends reinvested and that batting average jumped to 80%."
In other words, in most years, you're more likely to see gains by December 31st than losses.
And over rolling 10-year periods, the median annual gain was almost 12%, Stovall said. And cumulatively, "the S&P 500 rose an average 202% during each 10-year period."
The trick, of course, is that to achieve those gains you need to stay in the market through the peaks and troughs instead of trying to time the market. That's because research has consistently shown that investors aren't smart enough to know which stocks will go up and which one will go down — and when and for how long. You're better off owning a broadly diversified portfolio and holding on for a long time.
Put Things in Proper Perspective
Equating investing to gambling is a natural response to recent events, but the wrong one, says BlackRock chief investment strategist Russ Koesterich.
While the stock market will exhibit volatility in the short term, young investors "have a lot of time to bear that volatility and the difference between making even 5% to 6% in the stock market, relative to what you're going to make in a bank account, is going to have an enormous impact on how and when you can retire."
Humans are not purely rational beings who make short-term decisions with long-term consequences in mind. We're not Vulcans. "It doesn't come naturally for most people to have a very unemotional systematic approach to investing despite the fact that every single study says that's the best thing to do," says Koesterich.
What can you do? Try not watching financial television, or at least train yourself not to act on every bit of news. Whether you realize it or not, each buy or sell decision is an implicit bet on your ability to know which way the wind is going to blow.
And no one is that smart.