The Most Important Retirement Chart You’ve Ever Seen | Smart Change: Personal Finances
There are many important charts for investors, but there is one very powerful one that demonstrates the most retirement planning principles. If you interpret this chart correctly, you will understand the basics of portfolio allocation theory. You’ll be in great shape if you combine this knowledge with some discipline to develop an investment strategy.
Returns over different durations
This chart displays the percentage frequency of positive returns over various rolling periods throughout the history of the stock market.
The chart shows that in about 70% of cases the stock market has gone up in a given four-month period. This frequency rises to 80% for two-year windows and 90% for six-year windows. This general upward trend continues up to 16 years, beyond which the stock market has never recorded a net loss.
People also read…
We can conclude that equities are a safer bet for growth over long periods, while shorter periods are less predictable. Over a sufficiently long period, there is no historical precedent of negative returns. This may seem like a simple observation, but it has major implications for retirement investing strategies and portfolio construction.
What causes this pattern?
Trends and past performance are not necessarily indicative of future results, but it is important to reflect on the forces that have driven returns throughout history. It is not by chance that the graph takes its shape.
Think about the forces that determine the value of a company. The value of a stock reflects how much people are willing to pay to buy it at any given time – it’s basic supply and demand. In turn, supply and demand are influenced by capital market conditions in the macroeconomy, as well as the cash flows that investors expect from a company.
If a company is going to generate more profits than expected, then that company is worth more to the shareholders who can receive those profits. Equity prices are also driven higher by factors such as interest rates, inflation expectations and investors’ risk appetite.
Accordingly, there is a distinction between short-term and long-term drivers of stock values. The market as a whole is expected to grow along with the global economy. Employers who hire, consumer spending, and entrepreneurs who innovate all lead to increased economic activity. This increases the amount of cash flow generated by companies and ultimately results in higher stock prices.
Things can absolutely be disrupted in the short term – just look at the Great Financial Crisis, the dotcom bubble or the COVID-19 pandemic. However, the global economy has a repeated tendency to run out of steam if we give it enough time.
What does this mean for retirement planning?
This tells us a lot about growth and volatility, which is necessary information if you want to build a successful retirement portfolio.
History tells us that volatility is not a huge risk over periods of 15 years or more. If you have a long-term time horizon and have the discipline to stay invested during market downturns, then you can confidently invest for growth. A diversified portfolio with high exposure to stable growth stocks is a powerful tool for young people investing in a 401(k) or IRA.
On the other hand, negative returns are quite common for shorter periods. Sometimes these losses can be very significant. All sorts of weird and unpredictable events have triggered fixes and crashes throughout the story. Investors with shorter time horizons cannot necessarily afford to bear losses. If you’re less than 15 years from retirement, you need to take steps to protect your investment portfolio. As you approach 50, it’s time to start locking in some gains and increasing exposure to bonds, dividend-paying stocks and other low-volatility asset classes.
If you follow this formula, you will greatly improve your chance of making responsible long-term gains – and reduce the risk of losing those gains in a downturn in the market.
10 stocks we like better than Walmart
When our award-winning team of analysts have investment advice, it can pay to listen. After all, the newsletter they’ve been putting out for over a decade, Motley Fool Equity Advisortripled the market.*
They have just revealed what they believe to be the ten best stocks for investors to buy now…and Walmart wasn’t one of them! That’s right – they think these 10 stocks are even better buys.
Equity Advisor Returns 2/14/21
The Motley Fool has a disclosure policy.