Viewing Stock Market Risk Over The Long Run

The following is a chart that I usually like to pull out during a crisis when people are scared of investing in the stock market, but since I just found a nicely updated version of it, I had to share. It is taken from Jeremy Siegel’s book Stocks for the Long Run and found via this Vox article about how most people incorrectly view real estate as the best long-term investment*.

Here is a chart showing the historical range of real (after-inflation) returns for US stocks, long-term bonds (bonds), and short-term bonds (T-bills) from 1802 to 2012.

The chart shows that over bried time periods, the stock market has been historically more of coin flip than anything else. Over a year, you could get anywhere from +70% to -40%. With bonds and cash, the swings are much less wild. But as you lengthen your holding period, your risk of losing money over that time decreases significantly. For time horizons of 20 and 30 years, only stocks never lost you money after inflation.

Note that the average annual returns for each respective asset class remains the same across all time periods. Via the CFA Institute:

This supports the advice that it doesn’t really matter as much what your plan is, but more that you pick one and stick with it. Going heavy on stocks and then bailing out when they are in a funk, or going heavy on bonds and bailing out when they are in a funk, all that is worse than doing NOTHING and simply riding it out. As they say, it’s not about timing the market, it’s about time IN the market.

I believe it was one of William Bernstein’s books that suggested that young folks who understand this should put as much money now into stocks as possible, as to increase your time horizon. Put 100% of your money into stocks now, and then as you get older put more of your money into bonds to get a balanced mix eventually. This can be hard though, as you’re asking the people with less experience and smallest assets to hold the thing that is most volatile. Going 80/20 or 70/30 from beginning to end is also a reasonable approach in my opinion (and personal experience with my own portfolio).

Now, another well-known professor Robert Shiller reminds us that the period above includes the most economically successful century of the most economically successful country in the world so far… and will not necessarily repeat itself. I’m not saying that you should expect 6% real returns from stocks. Shiller’s CAPE ratio model itself forecasts a 3% real return for stocks over the next decade. I’m focusing on the fact that stocks are investments in productive businesses and that the volatility of the pricing of such businesses will stabilize when held across longer holding periods.

* I would actually argue that the long-term return of real estate is actually not that far behind that of stocks, if you add in the imputed rent from the house. Yes, it may be true that the value of a house doesn’t increase that much over inflation over the long run. But houses are also productive in that they can create their own income! If the value of the rent that you could get from that house is included, that could add another 4% to 6% to the return historically. 5% real return would be smack dab between bonds and stocks.