Long Term ETF Investment in Stock Market - Free Financial Advice

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Long Term ETF Investment in Stock Market - Free Financial Advice

STOCK MARKET PERFORMANCE ON LONG TERM INVESTMENT

The beginning of 2016 has seen the Stock Markets affected by an increase in volatility and dire performance. The S&P 500 had its worst start to the year on record, and major stock markets around the world also saw large declines. Various factors have come into play at the same time; sluggish growth in Europe, a sharper decline than expected in economic activity in China and concerns of interest rate increases in the US suffocating expansion in the world's largest economy.

Stock market reaction's to headline news and subsequent declines should be read under a less worrying light. Investors should have a much longer investment horizon than they typically give themselves. US Stocks have consistently outperformed inflation and, therefore, generated real returns despite various drawbacks.  The level of real return has shown an attractive rate over the past 60 years.

HOW DOES US STOCKS PERFORMED HISTORICALLY?

Looking at total return, which includes dividends, since 1965 for the S&P 500; the average annualized return was 11.20%. But what really is interesting is how well stocks performed when compared to inflation. Inflation decreases the value of your money and investments are only really profitable when they beat it on a consistent basis.

Average annualized inflation-adjusted return for the S&P 500 over the same period was 6.96%. This means that $1 invested in 1965 would now be worth $15.16 when adjusted for inflation.

That number may sound underwhelming, but if you consider that as it discounts inflation, the multiplier of 15 gives the increase in your actual purchasing power. In Money terms, as annualized return for this period was 11.20%, $1 would have grown to $114.89. So a portfolio of $10,000 that had been invested in the broad stock market would now be worth $1,148,900. With this number, it is perhaps easier to appreciate the extent to which the stock market actually beat inflation.

stocks vs inflation

IMPORTANCE OF LONG TERM INVESTMENT HORIZONS

History, in investments at least, tends to repeat itself. It is therefore necessary to approach investing with this concept in mind. If we look at a chart for the stock market we can see how after every recession or stock market bear trend, prices have always returned to higher levels within a few years.

The most recent stock market crash saw prices reach a 60% draw-down from their high in 2007. Yet by May 2013 the market had already fully recovered lost ground and was trading again at 2007 highs. The market has since continued that rally and set a new all-time high in May of 2015.

Stock chart

As the chart shows above every decrease in stock market price is then followed by a recovery and eventually new highs. Bear trends in the US stock market have typically not been longer than a few years. There is only one sustained bear trend that started in December 1965 and continued to June 1982. The rest of the bear trends lasted no longer than 5 years which was the length of the post-World War I bear trend from September 1915 to November 1920. The stock market crash that preceded the Great Depression lasted from September 1929 to June 1932.

Ultimately, even when buying at the top of a bull trend, an investor with a passive investing strategy will still come out a winner in the long run. Not only may he come out a winner but large drops in price can be an opportunity to buy stocks at a discounted price.

When markets enter into panic mode, investor will tend to push price way beyond fair value. This means that adding stocks to a portfolio every year that the market declines to lower prices, will put an investor in a better position to benefit from the eventual market recovery.

LONG-TERM INVESTING ALLOWS FOR THE POSITIVE EFFECTS OF RE-BALANCING

The table below shows what would happen if an investor entered the broad stock market and invested in the S&P 500 in May 2007, at the top of the market before the crisis hit. However, this investor rebalances his/her portfolio by adding the percentage amount in US dollars by which the market had dropped.

Invester deatils

You can see that by May 2009 the investor would still have $10,000 invested in stocks, but at a much lower average price of 1313.21 and would also own more shares. Both factors help making this portfolio profitable earlier. Despite a total invested of $14,287.40, this rebalanced portfolio would have seen breakeven by May 2010 as the S&P 500 went past 1313.21.

Benefits of Rebalancing Portfolio:

  • Stable Returns On Investment: In long term investments rebalancing portfolio helps investor to get stable returns despite of massive correction in market.
  • Boosts Confidence: It helps to boost the confidence of investor in stock market as investor instead of getting depress by heavy falls in stocks prices tend to buy more and more stocks in order to rebalance portfolio.
  • Minimizes Risk: Portfolio rebalancing not only helps to get recover from the huge loss it also helps to gain more profit in longer investment horizon.

Rebalancing can only be contemplated when the investment horizon is long term. The most recent financial crisis saw a sharp drop in stock prices but even though it did not last very long, most investors would have panicked and sold.  However, a recession or a bear market may also last several years and, therefore, the investment horizon needs to be long term to implement rebalancing and ride out the downtrend.


Author: Gino D'Alessio

 


 




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