Investing Without Fear Or Regret
Stocks have reacted favorably to the recent election results, deemed by some to be the “Trump Effect”. Optimism is up, people are feeling better about the economy. But what does this really mean? Emotional investing tends to get us in trouble, so the question I wanted to answer for myself is what time horizon should the average investor have prior to investing a dollar into stocks, whether funds or individual securities.
I went back to 1900 and analyzed the S&P500 or equivalent market returns through 2016, with 3, 5 and 10 year rolling periods. What I found is that you should preferably have a 10 year time horizon (or longer) to let stocks do what they do best, which is to grow your money over time. (Yes, I know dividends are important, but for this article we are talking about Total Return, with dividends re-invested)
Here’s why: from 2000 through 2016, a 3 year rolling average annual return was 5.77% with 15 periods measured. However, depending on the year you started, you could have experienced a whopping negative 14% average annual return, and one third of the time periods you would have had negative average annual returns. That means you would have had less money after three years than you started with. With a 5 year time horizon, the average annual return was 6.1%, no big improvement, BUT your worst period would have returned a negative 2.4% average annual return. And, there were only three periods of negative returns out of 13.
So by adding two years to your investment time horizon, you do yourself a huge favor with respect to the outcome. Does this mean the next five years will be the same? Who knows? We look to the past to preview the future. It’s about all we can do, right?
The bottom line is that, as every mutual fund prospectus I have ever read states, you should not invest in stocks unless you have at least a 5 year time horizon where you are willing to ride the waves up and down. 10 years is much better: Average annual returns for 10 year rolling periods from 2009-2016 were 6.1% with no negative average annual returns for any of the 8 periods measured.
NOTE: the annual returns I mention are the geometric returns, or IRR’s (aka CAGR), which means they are the actual returns, not some smoke and mirrors average. Also, the returns exclude management fees and transaction costs, so in the real world your returns would be somewhat less.