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Bill Freehling is a business writer for The Free Lance-Star and Fredericksburg.com. This blog is on Fredericksburg-area business. Send an e-mail to Bill Freehling.
Higher risk equals higher returns for investors
MANY PEOPLE don’t invest in the stock market because they think it’s too risky.
They’d rather plow their hard-earned money into the safe pastures of CDs, government bonds and money market funds.
That makes a lot of sense for money needed in the short-term. As this summer’s stock market volatility shows, money that’s immediately needed shouldn’t be riding the choppy seas of the stock market.
But as James K. Glassman points out in an excellent column in the November edition of Kiplinger’s, the stock market’s riskiness is precisely what typically makes it one of the best bets for long-term investors.
As Glassman points out, stocks have returned about 10 percent annually over the past 80 years, easily trumping the returns of bonds or shorter-term cash investments. One reason: Stock investors get higher returns to accept more risk.
“If you want higher returns, you have to accept the thrills and spills that accompany them,” Glassman said.
Thrills and spills had been noticeably absent from the stock market for the four-year period starting in 2003. During that time, the Standard & Poor’s 500 returned 29, 11, 5 and 16 percent.
That’s significantly lower volatility than has been traditional for most of this century. Glassman says that was due to a healthy economic environment with low inflation, steady interest rates and a rising gross domestic product.
Problems in the U.S. mortgage market returned volatility to stocks this summer. Over the last five trading days of August, the S&P dropped 6.3 percent.
Many investors fled the stock market during that turbulent time. But they’re probably kicking themselves now, as markets have recovered and hit new highs.
Glassman points out that the biggest challenge for investors is not picking the right stock or mutual fund but “enduring the anxiety and fear of owning something that could be worth a good deal less tomorrow than it is today.”
As Warren Buffett has said, uncertainty is “the friend of the buyer of long-term values.” Recent market dips, as they always do, provide opportunities to buy good companies on sale.
Glassman’s column points out that the definition of risk depends on one’s timeline. Since 1926, the major stock indexes have lost money about once every three to four years. But over 15-year periods, stocks have always returned positive returns. Meanwhile, a 3 percent inflation rate has cut the supposedly risk-free returns offered by CDs and bonds.
Even this past summer’s volatility wasn’t so dramatic when measured in longer periods. In July, the worst month of the summer, the S&P fell just 3.2 percent.
It’s worth noting that as the markets have risen over the years, 100-point or more drops in a single day are no longer that significant. The 387-point fall in the Dow Jones Industrial Average on Aug. 9 was a 2.8 percent decline–equal to a 70-point drop in 1990.
Glassman’s column is titled “The Upside of Risk.” It’s a most appropriate title for the long-term buyer of stocks blessed with a strong stomach for short-term volatility.