Getting the willies from the stock market’s recent stomach-churning drops? Wondering whether a growling bear is ready to descend on Wall Street? Thinking it might be time to get out–or at least stop putting money in–while the getting is still relatively good?
Before you do, take a moment to consider a short history of the U.S. stock market. Obviously, history can’t telegraph tomorrow’s activity, but it certainly proves instructive for anyone who invests to satisfy short- and long-term goals.
The genesis of the U.S. stock market came in a document called the “Buttonwood Agreement” that was signed by 24 stockbrokers and merchants on May 17, 1792, and provided the basic structure for what’s now known as the New York Stock Exchange. (These early traders used to meet under a buttonwood tree on Wall Street, resulting in the unusual name.)
As is true today, companies sold their shares into the open market for a simple reason: They needed cash to grow. However, no one actually charted how fast they grew–nor how well investors in these companies fared–until 1884 when Charles Dow, a financial journalist, constructed a simple index of 11 industrial stocks, which was later expanded to 30. This index is now known as the Dow Jones industrial average.
The Dow remains the best known and most widely quoted of all U.S. stock averages. However, there are a plethora of additional stock market indexes that are used to gauge the performance of the market as a whole as well as specific industry groups. The index most widely used in market research is called the Standard & Poor’s 500. Because it tracks 470 more stocks than the Dow and uses sophisticated market weighting techniques, it is believed to be more indicative of the market as a whole.
So, how has S&P performed over history? Like a seismograph.
During the past 70 years, the S&P index has been up as much as 53.9 percent in a single year and down as much as 43.3 percent, according to Ibbotson Associates, a Chicago-based market research and consulting firm. There have been nearly two dozen months with double-digit percentage-point drops and roughly three dozen with double-digit gains.
However, in the aggregate, U.S. stocks have posted an average annual return of 10.5 percent over the 70-year period. During the same time, long-term U.S. bonds posted an average annual return of 5.17 percent; Treasury bills rose 3.72 percent on average; inflation has averaged 3.12 percent.
That means that someone who invested $1,000 in the S&P 500 in 1926 would have about $1,112,659 today without investing an additional penny. (You can’t invest directly in the S&P 500 index, but if you have a diversified portfolio of big company stocks, it’s likely to mirror the performance of this index.)
As those single-year and single-month statistics indicate, volatility is pivotal for stock market investors who might need their money in a hurry. However, the importance of market volatility tends to recede with time.
Specifically, if you look at five-year “rolling” average returns, you find that the worst average annual loss amounted to 12.47 percent. The biggest average annual gain was 23.92 percent.
And the longer the holding period, the less the risk of significant average annual losses. For those with 10-year horizons, the worst average annual loss amounts to about 0.9 percent, while the biggest average annual gain over 10-year periods amounts to 20.1 percent. Over a 15-year period, the worst-case scenario results in a positive 0.6 percent average return, while the best is 18.2 percent annually.
“Since we have not seen any fundamental changes in the stock market over the past 70 years, we expect that the market will continue to perform as it has historically,” says Todd Jaycox, an Ibbotson consultant.
For individual investors, the message is simple. If you have a portion of your money in stocks because you have a long-term goal that requires savings and appreciation, you can’t be in a better place–no matter what happens over the next day, month or year. But the stock market is not a place for all your money. And it’s certainly not the place to invest money that might be needed tomorrow.
