According to a recent survey released by Prudential Financial, fear and disillusionment have once again grabbed hold of many individual investors. Nearly 60% of the survey respondents said that they had "lost faith" in the stock market, while 44% said that they are unlikely to ever put more money in the stock market again. (Why have stocks historically produced higher returns than bonds? It's all a matter of risk. Check out Why Stocks Outperform Bonds.)
TUTORIAL: Investing 101
Those are sobering statistics, but not terribly surprising. When times are good and the markets are running hot, people feel great about the markets and throw money at stocks. When times are bad, people swear off the markets and promise "never again" - until the next big thing dominates the headlines again.
For those who don't wish to ride that pendulum between frenzy and despondency, there are several solid reasons not to fear the market.
1. Volatility Is Not Risk
Investors should perceive the difference between long-term risk and short-term volatility. Risk is the chance that an investor experiences a permanent loss of value, while volatility is the turbulence along the way. Although it is not exactly true to say that an investor has not really lost anything until he or she sells, it is true that no stock ever goes up in an unbroken line; there are always pullbacks and sell-offs. Most people would not quit a job, sever a relationship or abandon a friend over one or two rough patches and the same should be true of the stocks of solid companies - a momentary setback is just that and one or two down years is no reason to abandon an investment (or investing altogether).
2. Long-Term Losses Still Rare
It may seem crazy to raise this point in the wake of a decade that saw the tech bubble crash and the housing market drag down the stock market, but long-term losses in the stock market are actually uncommon. It is true that the Nasdaq still has not regained its tech-bubble highs, but the S&P 500 and Dow Jones Industrial Average both did before investors fled the market amidst the credit crisis and pushed them down to the post-tech bubble lows again.
In point of fact, it is uncommon for the markets to be down over five-year stretches and very rare to see long-term declines beyond that length of time. That means that investors who can block out the volatility and stick to their plan do win in the end. Invest less money when stocks are overpriced (when you have a hard time finding bargains) and you limit the damage even further.
3. The Market is the Only Proven Way to Outpace Inflation
The stock market happens to offer one of the only proven ways to grow wealth faster that the rate of inflation. While bonds rarely offer more than 1% or 2% more than inflation (and sometimes much less), stocks have historically offered much better returns. This is a key consideration for those saving for retirement, as inflation represents a persistent economic loss on your savings and investing too conservatively (i.e. not beating inflation) is tantamount to locking in that loss.
Some will argue that gold is just as good at outpacing inflation, but the record on gold is dicey. Long stretches of outperformance in gold are frequently followed by major pullbacks, and it often takes decades to see those inflation-beating benefits. Unlike stocks, it is much more common to see five or ten-year losses in gold.
Likewise, real estate is another asset class famous for beating inflation, but like gold it is prone to huge run-ups and crushing pullbacks. Real estate also requires a large amount of capital and a fair bit of savvy from investors and is not nearly as accessible as the stock market.
4. Good Managements Create Real Growth and Value
The best that a bond investor can hope for is to be paid back in full, while gold investors have to wait and hope that some future buyer will pay more for those bars or coins than they did. With stocks, though, investors buy actual ownership in a business entity. Time has shown over and over again that talented managers do create real growth and real increases in value.
A gold bar will always be a gold bar - nothing less and nothing more. A share of Apple, Chipotle Mexican Grill or Alexion, though, is something much different today than it was just five years ago.
5. Fear Is a Contrarian Indicator
One of the best reasons not to fear the market today is that so many other people do. The stock market often offers the best values precisely when investors want nothing to do with it. Those who can control their fear, find the undervalued stocks and not abandon their strategy will often find that they end up paying much less than those who run hot and cold on the market. This is not easy to do - human instinct says that if everybody is fleeing from the same direction, you shouldn't go there - but success in a market of human beings often demands that you be less emotional and more patient than the crowds are capable of being. (Buying at the right price determines profit, but selling at the right price locks it in. See When To Sell Stocks.)
The Bottom Line
One of the fundamental traits of fear is its persistence - there is always something to be afraid of if you want to find it. In terms of investing, it is said that the markets are always in a tug of war between fear and greed, and this recent survey from Prudential suggests that fear is now winning the battle. Patient investors should see this as an opportunity to buy and should remember that the stock market offers numerous valid reasons to continue investing. There will be tough stretches and investors should not blindly throw money at stocks no matter what the valuation, but investing rewards patience and discipline and the stock market still represents one of the best opportunities that regular people have to build wealth.