Many people tell me that when it comes to investing aggressively, fear often gets in the way. But when I talk to them, I quickly find out that their fear is based on their emotions, and just by having more information, they can get over their fears and start investing wisely. Too often, our fears are unwarranted and we don’t even know it.
For example, here are some comments I’ve heard from my friends just in the recent months:
“Other than my real estate properties, I hold a lot of my assets in cash. I just can’t go into the stock market, I’m scared that it is way too overpriced.”
“I just sold all of my stocks recently. I’m glad I did it because the stock market hasn’t gone up at all this year.”
“It took 25 years after the Great Depression for the market to recover. I can’t risk an event like that happening again. I can’t afford to wait 25 years to get my money back.” (This is not true by the way, it doesn’t take 25 years to recover, as I’ll argue in this post.)
All of these fears are understandable. Just the potential of losing money is scary, and I actually used to have the same fear before I studied about this topic more and have come to the understanding that my fear was purely based on the lack of my knowledge.
Having said that, there are a few things that you must understand when investing for the long-term.
You will lose money in some years.
The stock market does not always go up. So if you’re invested in the stock market, you will lose money in some years. I lost close to 40% of my assets in 2008. And guess what? That’s totally okay! You’re actually in good company when you lose money, because even Warren Buffett, the world’s best investor, loses money in those years too. Which leads me to my next point:
You will gain money in most years.
And these years are quite profitable. Way more than enough to make up for the lost years in my first point.
You cannot predict which year will be which.
This is really important. You cannot predict the market. That doesn’t mean the market is completely random. There actually are ways to evaluate whether the market maybe over or under-priced, and one good way is to calculate the price-to-earning (P/E) ratio of a broad stock market index and compare it to the historical average. But even with that information, you still can’t predict what the market will do that year. Take 2017 as an example. It seemed that the market was overpriced at the start of the year. Seeing that the market is overpriced, an investor could have sold all his stocks predicting that it will go down (sadly, some people actually did). Well guess what? By the end of the year, the market gained a whopping 21.7%!
It’s costly to be NOT invested in the market.
It is tempting to sell your stocks when the market seems overpriced. But when you sell your stocks, you miss out on the potential growth, and history has shown that the market tends to have just a few days every year when the most significant growth occurs (we’re talking multiple percentage points in a single day). The only problem is, nobody can predict when those days will come. So how costly is it when you miss out on the few good days? Consider this fun thought-experiment:
Suppose you had $100,000 on January 1st of 1994, and decided to invest all that money for two decades, ending on December 31st of 2013. That’s a total of 5037 trading days. If you kept all of the asset in an S&P 500 index fund for all of those trading days, you will have a hefty $583,520 sitting in your account at the end of the experiment. Cool! You survived the dot-com crash of 2001 and the housing-crash and financial melt down of 2008 just fine, and you can now retire comfortably on your money. Readers in Los Angeles or New York might disagree and argue that they need a few million dollars to retire, but remember, the reason why people seek to live in these expensive cities in the first place is because of the wealth of economic opportunities close to a center of commerce. But if you are financially free, the prospect of a well-paying job doesn’t factor into your decision anymore. You can pretty much live anywhere in the world at that point.
Now, to continue with the thought experiment, consider this alternative: Suppose that instead of investing your money for the entirety of the 20-year duration, you took your money in and out of the market due to fear, and you happen to miss out on forty of the best trading days during the 5037 trading days span (that’s less than just 1% of the duration). Guess how much you’d have at the end. A mere $81,490. Remember, you started with $100k. You actually LOST money over those twenty years, simply by missing out on those forty days of trading. It turns out that fear could be very costly.
When it comes to making a financial decision, you are much better off going with what the research says, not what your emotion tells you to do. And the research says that the people who stay invested see much better returns than people who try to time the market. So stay invested at all times.
Count your wealth by how much of the economy you own, not dollars.
Money is just a piece of paper. Although it is a pretty useful piece of paper for trading goods, there is no inherent value in it. But so many people think that there is. I even know of an extreme case of a family who holds most of their assets in cash hidden in various places of their house. They do things like that because they think that money is valuable. It is not. When you hold onto cash, you are actually constantly losing wealth over time, because the purchasing power of a dollar diminishes over time. Economists call this “inflation”. Just think about it. A person could buy a hamburger for 12 cents in 1950. Well, that’s not true anymore, in fact you can’t buy much of anything for 12 cents nowadays. So by keeping 12 cents under your bed thinking that you could treat yourself to a nice juicy burger in some future date, you lost all your purchasing power. That’s essentially what happens when you just keep cash. Money loses value over time.
But it is so tempting to compare prices simply in terms of dollars. I’ve met some old people who talk about the “good old days” when everything used to cost cents. Well they forgot one important factor: their wages were much lower then too, and their purchasing power was actually lower in those “good old days”. Most of them couldn’t afford a color TV, for example.
It’s also the same misunderstanding that causes people to think that they got a raise when their salary goes up, because they simply look at their wealth in terms of dollars. If your salary goes up by 1% every year, you are not getting a raise. In fact, your income went down, because inflation raises the consumer price index by more than 1% per year.
When you think that your wealth is measured in dollars, it makes sense that you would have an aversion to loss by investing in the stock market. After all, your $100 today could suddenly drop to $60 tomorrow, and it appears that you “lost” your wealth. But that’s not how I think of it. I count my wealth in terms of the proportion of the world’s economy that I own, because essentially, that’s what I am buying when I invest in index funds. Suddenly, the ups and downs of the market don’t affect my emotions anymore, because even if the market crashes tomorrow, I still hold the exact same percentage of the economy. So my wealth hasn’t really decreased, first, because prices of goods also drop with the market keeping my purchasing power relatively stable, and second, now those shares are at a steep discount! If the market crashes and loses half its value, I can afford to buy double the shares for the same amount of dollars all of a sudden! So the market crash is not bad at all. In fact, it’s a great opportunity for me to keep investing.
When you invest consistently, you naturally end up buying more shares when they are discounted due to downturns, and that leads to a significant wealth over time. Market downturns are actually to your advantage.
It won’t take 25 years to recover from a crash.
This is partially related to my last point. If you simply look at it in terms of dollars, it does appear that the recovery from Great Depression took 25 years. But you know by now that your wealth is not to be counted in dollars. Remember, this was a deflationary period when the prices also went down, so if you just look at purchasing power alone, it turns out that the recovery only took 4.5 years, not 25. Plus, this person was assuming that he invested ALL of his assets right before the market crashed, and didn’t invest a single dollar after it crashed. But that’s not what you’d be doing if you’ve been reading my posts. You will likely start investing way before the market crashes and see significant growth in your funds that makes the loss of a crash not hurt as much. And even if you do get unlucky and invest a significant amount of money right before a crash, as long as you keep investing after the crash, you will still be in golden shape.
So there you have it. Hopefully now you have a better understanding of the market, and are not that afraid to invest. There’s no telling when the next crash is. It might happen tomorrow. It might happen in 20 years. It doesn’t matter. Just keep investing.