Everybody knows the saying “time is money”. But in investing, the reverse is also true – “money is time”.
That is, a lot of investing is about building wealth through time. The younger you start, the richer you are likely to be when you retire.
And historically, one of the most effective ways to build wealth has been through investing in stocks. That’s because time in on your side. Here, I’ll explain why.
Stocks for the long-term win
Over the 90-year period from 1926 to 2016, US stocks registered compound annual returns of between 10% (for large companies) to 12% (for small companies).
And Treasury bills (which is considered a risk-free investment) earned only 3.4% per year. On the other hand, inflation eroded the real spending power of money by 2.9% a year.
Taking a shorter period of time, between 1998 and 2017, US$1 invested in US stocks would have registered compound annual returns of between 7% (for large companies) and 10% (small companies).
The safe-haven asset, Treasury bills, returned only 1.9% a year. It fell behind the inflation rate of 2.1% a year.
As for cash – that metaphorical “money under the mattress” – it lost one-third of its spending power over that time.
While Asian markets have shorter histories, it is still true that, over time, stocks generally turn in much higher annualised returns than bonds or cash.
Crucial to start young
Of course, there are periods of volatility when there could be losses in your stock portfolio. That’s why it’s critical to start young. That’s the power of youth – you have many years ahead of you to ride through the rough patches.
The long-term history of stocks is about ups and downs – that’s normal.
Stock markets go through cycles. But in sound economies, stock prices generally go up and down against a rising trend line.
Buy and hold for best gains
As young investors, you want to ensure you stay invested for the long haul. There’s a reason for that.
International investment firm Morningstar’s estimate of one-year returns for US stocks in the period 1926 to 2017 puts the periods of gains at 74% versus 26% for periods of losses.
But as the period of returns lengthens, the odds of making money rises dramatically. For five-year annualised returns, the periods of losses is cut to only 14%.
By the time Morningstar got to 15-year annualised returns, the periods of gains were 100%. Amazingly, that means no periods of losses.
Getting rich through patience
So, consider a 25-year-old in the year 1980. They start investing in the US-based S&P 500 index in January of that year, starting with a lump sum of US$10,000.
Thereafter, they invest additional amounts of US$100 at the end of every month. Today, the 25-year-old has become 66 years old and likely at the beginning of their retirement.
The total investment (on a simple historical cost basis) would have been US$59,100. That is the total amount of money invested over that period.
So, by putting that to work in stocks, they would now have a nest egg worth around US$1.36 million. That’s an annualised return of 10.6%.
Yet if they had invested in the relative safety of the 10-year US Treasury bond, the annualised return would have been significantly lower at 6.4%.
That same investment outlay (of US$59,100) in the 10-year US government bond would have grown to only around US$350,000 today – basically one-quarter the size of the stock-invested nest egg.
All these data points illustrate the importance of starting to invest in stocks young but, perhaps more crucially, also staying invested over time. It might sound boring to some of us but, when investing, patience certainly pays off.