Do Stock Prices Rise More Often Than They Fall?

This was the question posed by a mutual fund company in a recent email to financial advisors. Yes, it is that time where the mutual fund industry bombards advisors with information that they in turn can share with their clients. They send out tons of information to help advisors justify to their clients that buying and holding through a bear market makes sense.

This recent hand-holding email arrived in my inbox yesterday. After reading it, I decided that I wanted to share it with you so that you can understand the difference in what you are being told versus the reality of the situation. So let’s talk about risk today.

First let me set the stage – The mutual fund and financial services industry has one strategy when it comes to investing – you buy and hold for the long-term. The industry feels that this strategy, along with diversification, helps you weather any storms. This is an easy concept to sell and requires no effort amongst advisors in regards to management. It also protects the mutual fund industry from clients removing money from investments in down markets. So, during the difficult times, the industry does everything possible to equip advisors with what they should say.

EMAIL:

Situation: Your clients are jittery about a weak economy and turbulent financial markets.

Solution: Inform investors that we’ve been here before and stocks have a track record of bouncing back.

Discussion: On a calendar basis, the Dow has risen almost twice as often as it has declined. History shows us that stock prices have rallied amid rough economic periods.
There is more than a century of proof that despite periodic downturns in stock prices, equities have been an outstanding long-term investment. Since the Dow Jones Industrial Average’s inception in 1896, it has posted positive returns 72 years vs. 39 years of negative returns. It has produced an average annual return of 7.6%.

So this is the conversation that advisors are to have with their clients:

“Mr. and Mrs. Client, although you have lost a lot of money, everything will be OK. The Dow has had many more positive return years than negative. The good outweighs the bad by almost 2 to 1.”

The problem with that logic is two-fold. First, most people don’t have 100 plus years to stay invested. Thus, I have always thought that was somewhat of a weak argument. Second, they measure risk from the basis of gain and loss only. In reality, risk (which is the focus of the worry) is measured not only as gain or loss but also in terms of time.

Sure, there are more positive years than negative years of performance. There has to be more positive years for a good reason. It takes so many more positive years to make up for the damage done by the negative years.

The bear market of 2000 to 2002 wiped out five years and nine months of investment gain. It then took another seven years just for investors to get back to the amount of money that they had before the bear market even began.

It took four years of losses between 1929 and 1932 to deplete twenty-eight years of gains.

The financial services industry doesn’t address risk in the proper way. They just show you pictures and graphs of a stock market that goes up. That doesn’t ell the entire story.

Risk does matter. It is important to have a strategy other than just buy and hold when things get so risky in the stock market. It isn’t just about loss of value. It is also about loss of time. I would suggest that time is the bigger risk of the two.

You always have to look at risk from the standpoint of the effects of gain and loss and time. If you are in a situation where your current investment strategy could lose the type of money that would wipe away years of progress, then you are taking too much risk.

Copyright © 2008 Prudent Money and Bob Brooks. All rights reserved.