11 Oct Stay the Course! Comparing 5-Year Trailing Equity Returns
A common question many investors struggle with is how to balance having cash on hand while simultaneously investing for the future. While we recommend clients have 6 months of living expenses set aside to cover unforeseen expenses that only solves half the question. Dealing with how much money to invest and for how long becomes a critical subject to deal with for long-term success.
Producing positive returns over time requires a defined strategy, consistency in your approach and patience. A frequent trap that new investors fall into is moving money in and out of the markets, especially the equity markets, too quickly. Day-to-day, month-to-month and even year-to-year equity markets can produce negative returns. This uncertainty in the market is part of its DNA. The lesson that all investors must learn is that over more extended periods of time stocks typically (but not always) provide a positive rate of return.
The chart below is a visual representation of these returns. We examined the three major S&P Market Indices (Large-Cap, Mid-Cap and Small-Cap) and looked at their trailing 5 year total return (the combination of dividends and price appreciation). For example, the 2016 period looks at the total return beginning in 2012 and continuing through the end of 2016. When looking at returns over these extended periods of time what becomes evident is that even the most volatile (small-cap equities) class produce positive rates of return over extended time frames. Outside of the financial crisis years most aggregate rates of return over these periods were close to 100% of the initial invested amount. It is worth noting that this data does not take into consideration volatility which is often investors biggest deterrent to success.
It is for reasons like this we typically encourage clients to invest the funds that they do not believe they will need within the next five years. We have found that by mentally setting aside the funds for this period of time investors are better able to ignore the variances in the market and stay the course. By having this mental fortitude they are able to reap the benefits of investing in the stock market. Mentally this strategy works because there isn’t a near-term consequence (i.e. not being able to buy the car) if the market goes down and money is lost (temporarily).
Remember only invest what you are able to not touch for several years. By doing so you will give your portfolio a much better chance to make money over time.