Build Wealth In Falling Markets? Why It Doesn't Work
To build wealth, you take your savings and invest them wisely - and safely. At least you try to invest safely.
Some say safe investing includes the stock market. They point to all sorts of statistics that show you how, if you invest in the stock market for the long run, you've got your best shot at building wealth. As a matter of fact, they'll even tell you that it's OK to invest in falling markets, like the stock market's been falling lately, even though you might think that's a bit nutty.
Maybe you've seen those tables that show all those "10-year periods" where most of the time stocks are up after 10 years. That's one of the ways they convince you it doesn't matter that you're investing into a falling market. Look out 10 years and what do you see? Your money's worth more. And there's certainly some truth in what they say. The problem is that there's only some truth.
Let's take a look at two specific - and very common - situations where investing in stocks for the long run really doesn't work out.
First, let's say you've got some cash right now and you want to invest it for the long run. The first thing you've got to do is define what you mean by "long run." A lot of investment managers think of "long" as being maybe 5 or 10 years. I've even been in presentations where the investment manager talked about 3 years as being a long-term investment horizon!
So let's say you're 50 and you decide you want to retire in 10 or 15 years. You decide - or maybe your broker or advisor tells you - that the best way to build wealth is by putting all or most of the money in stocks. So you do that.
The thing about right now is that stocks aren't really priced to make money. You see, investing in stocks works really well when you buy them when they're cheap. And they're simply not cheap.
Of course, you'll find plenty of people who'll tell you they are. I'd ask "relative to what"? The reason I'd ask that is because, when you look back at the stock market history these folks use for their statistics and those 10-year periods and all that, you'll find that your chance of making money in stocks goes way up when you buy them when the average price earnings ratio of stocks is less than 10. (I'm talking about the trailing price earning ratio - not the usually optimistic forward (a/k/a projected or estimated) price earnings ratio.
Next, let's say that the price earnings ratio is relatively cheap. Maybe not below 10, but let's say not too much above that. Well, you've got a reasonable chance of making some money. (Of course, you might make money in bonds too - and they're a tad less volatile than stocks.) But here's the thing: you can't touch the money. Not at all.
Of course you can touch the money any time you want. It's your money after all. So if some emergency comes up and you need some money, you just call up your broker and get some money. Just don't expect to have anything close to what you had expected in 10, 15, or 20 years.
You see, any projections you see typically assume that 1) you're not going to touch the money at all 2) you will re-invest any interest and dividends that your stocks and bonds throw off.
And I have to tell you that I've rarely if ever seen anyone just leave their investment account alone. At some point they dip in. And the problem with that is that all the assumptions and projections go right out the window.
So I'd say that if you're investing when stocks are historically pricey - like now - or if you think you might need any of the money in your account at any time at all, you really ought to think twice before you put a lot of your money into stocks. Because all those statistics, projections and 10-year rolling periods simply won't hold up.
But what about when they say that you can't afford not to be in the stock market? You've heard that one, right? That's where they tell you that you can't predict when the market's going to go up. And they show you what happens if you miss out on when it does go up. It just kills your investment return.
Then again, they never show you how if you had missed all those other times, you know, when the market goes down. Guess what happens then? It does wonders for you investment return.
That's why trying to build wealth in a falling market can be a bad idea. And, funny, it's probably what you were thinking all along on your own anyway, right?
Some say safe investing includes the stock market. They point to all sorts of statistics that show you how, if you invest in the stock market for the long run, you've got your best shot at building wealth. As a matter of fact, they'll even tell you that it's OK to invest in falling markets, like the stock market's been falling lately, even though you might think that's a bit nutty.
Maybe you've seen those tables that show all those "10-year periods" where most of the time stocks are up after 10 years. That's one of the ways they convince you it doesn't matter that you're investing into a falling market. Look out 10 years and what do you see? Your money's worth more. And there's certainly some truth in what they say. The problem is that there's only some truth.
Let's take a look at two specific - and very common - situations where investing in stocks for the long run really doesn't work out.
First, let's say you've got some cash right now and you want to invest it for the long run. The first thing you've got to do is define what you mean by "long run." A lot of investment managers think of "long" as being maybe 5 or 10 years. I've even been in presentations where the investment manager talked about 3 years as being a long-term investment horizon!
So let's say you're 50 and you decide you want to retire in 10 or 15 years. You decide - or maybe your broker or advisor tells you - that the best way to build wealth is by putting all or most of the money in stocks. So you do that.
The thing about right now is that stocks aren't really priced to make money. You see, investing in stocks works really well when you buy them when they're cheap. And they're simply not cheap.
Of course, you'll find plenty of people who'll tell you they are. I'd ask "relative to what"? The reason I'd ask that is because, when you look back at the stock market history these folks use for their statistics and those 10-year periods and all that, you'll find that your chance of making money in stocks goes way up when you buy them when the average price earnings ratio of stocks is less than 10. (I'm talking about the trailing price earning ratio - not the usually optimistic forward (a/k/a projected or estimated) price earnings ratio.
Next, let's say that the price earnings ratio is relatively cheap. Maybe not below 10, but let's say not too much above that. Well, you've got a reasonable chance of making some money. (Of course, you might make money in bonds too - and they're a tad less volatile than stocks.) But here's the thing: you can't touch the money. Not at all.
Of course you can touch the money any time you want. It's your money after all. So if some emergency comes up and you need some money, you just call up your broker and get some money. Just don't expect to have anything close to what you had expected in 10, 15, or 20 years.
You see, any projections you see typically assume that 1) you're not going to touch the money at all 2) you will re-invest any interest and dividends that your stocks and bonds throw off.
And I have to tell you that I've rarely if ever seen anyone just leave their investment account alone. At some point they dip in. And the problem with that is that all the assumptions and projections go right out the window.
So I'd say that if you're investing when stocks are historically pricey - like now - or if you think you might need any of the money in your account at any time at all, you really ought to think twice before you put a lot of your money into stocks. Because all those statistics, projections and 10-year rolling periods simply won't hold up.
But what about when they say that you can't afford not to be in the stock market? You've heard that one, right? That's where they tell you that you can't predict when the market's going to go up. And they show you what happens if you miss out on when it does go up. It just kills your investment return.
Then again, they never show you how if you had missed all those other times, you know, when the market goes down. Guess what happens then? It does wonders for you investment return.
That's why trying to build wealth in a falling market can be a bad idea. And, funny, it's probably what you were thinking all along on your own anyway, right?
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