When investing, it's better to think about the long term
Investing is inherently risky; there鈥檚 never a guarantee of positive returns. But this year鈥檚 high levels of market volatility, coupled with , might leave investors wondering if it鈥檚 worth waiting for an upturn.
The answer is yes 鈥� and it has more to do with than the聽investment products you choose. Creating a well-balanced, diversified portfolio and investing for the long run doesn鈥檛 quite guarantee you positive returns, but it comes pretty close.
Stocks and bonds
If you鈥檙e looking for a guaranteed return, stocks probably seem like a bad choice. shows that stock market returns vary widely from year to year. Since 1928, stocks鈥� worst-ever one-year return was a loss of 43.84% in 1931. They had their best year in 1954, when they gained聽52.56%.
Investors consider bonds to be a safer investment than stocks, but they still experience volatility, and putting all your money in them聽is far from safe. 聽In 2009, 10-year Treasury bonds lost 11.12%, in their worst year ever. They gained 32.81% in their best year, 1982.
In theory, different asset classes perform well at different times 鈥� so diversification, or having a mix of assets in your portfolio, should help investors achieve better聽returns. But if you聽construct a hypothetical portfolio made up of 60% stocks and 40% bonds, returns still vary quite a bit.
According to my calculations, the worst single year for a 60/40 portfolio was 1931, when it sustained a 27.33% loss,聽and the best year was 1954, when it gained 32.85%.
Simple diversification helps, but it鈥檚 not enough.
Long-term investing is key
Financial markets don鈥檛 stay bad forever and they don鈥檛 stay good forever. Big swings occur on a yearly basis, but the long-term trend has definitely been positive. If you鈥檙e willing to ride out the ups and downs, you have a better chance of capturing the markets鈥� long-term positive trend.
Going back to our historical data and our hypothetical portfolio made up of 60% stocks and 40% bonds, you can see how this plays out:
| Timeframe | Years | Worst average annual growth |
|---|---|---|
| Source: Federal Reserve data from NYU Stern, calculations by Dave Rowan | ||
| Worst 1-year 60/40 return | 1931 | -27.33% |
| Worst 2-year 60/40 return | 1930-1931 | -20.60% |
| Worst 3-year 60/40 return | 1929-1931 | -15.21% |
| Worst 4-year 60/40 return | 1929-1932 | -12.01% |
| Worst 5-year 60/40 return | 1928-1932 | -5.37% |
| Worst 6-year 60/40 return | 1929-1934 | -3.59% |
| Worst 7-year 60/40 return | 1928-1934 | +0.24% |
By being willing (and able) to hold onto this simple portfolio for seven years, historical investors would have effectively guaranteed themselves a positive return. And we鈥檝e been focusing on the worst-ever returns. This hypothetical portfolio returns an average of 8.92% across all seven-year periods from 1928 to 2015 鈥� a result that would please most investors.
Consider your time horizon
Clearly, the longer you are invested in a mix of stocks and bonds, the better your chances of seeing positive returns. So if you have money to invest, but know you鈥檒l need it in five years or less, it鈥檚 probably best to stay away from these riskier assets. Instead, stick to , savings vehicles provided by banks that offer fixed interest rates. You won鈥檛 see much of a return, but it will be guaranteed聽and insured by the Federal Deposit Insurance Corporation, in many cases.
However, if you鈥檙e reasonably sure you won鈥檛 need the money for more than five years, consider investing in a diversified portfolio of stocks and bonds. History is no guarantee that you鈥檒l avoid a loss, but the numbers sure look compelling.
聽is a certified financial planner and the founder of聽. This article first appeared in .
