This is the whole reason to go through the effort of investing in stocks. Again, even if you had invested in stocks at the highest peak in the market, your total after-inflation returns after 10 years would have been higher for stocks than either bonds or cash. Had you invested a little at a time, not just when stocks were expensive but also when they were cheap, your returns would have been much greater.
Time is on your side
Just as compound interest can dramatically grow your wealth over time, the longer you invest in stocks, the better off you will be. With time, your chances of making money increase, and the volatility of your returns decreases.
The average annual return for the Standard & Poor's 500 Index ($INX)for a single year has ranged from negative 39% to positive 61%. Stocks held for five years have seen annualized returns ranging from negative 4% to positive 30%. This underscores the importance of a long-term investment horizon when you are getting started in stocks.
Why stocks perform the best
But why, exactly, have stocks been the best-performing asset class? And why should we expect those types of returns to continue? In other words, why should we expect history to repeat?
Quite simply, stocks allow investors to own companies that have the ability to create enormous economic value. Stock investors have full exposure to this upside. For instance, in 1985, would you have rather lent Microsoft (MSFT, news)money at a 6% interest rate, or would you have rather been a shareholder, seeing the value of your investment grow several-hundred fold over the next 15 years?
Because of the risk, stock investors also require the largest return compared with other types of investors. More often than not, companies are able to generate enough value to cover this return demanded by their owners.
Meanwhile, bond investors do not reap the benefit of economic expansion to nearly as large a degree. When you buy a bond, the interest rate on the original investment will never increase. Your theoretical loan to Microsoft yielding 6% would have never yielded more than 6%, no matter how well the company did.
The bottom line
While stocks make an attractive investment in the long run, stock returns are not guaranteed and tend to be volatile in the short term. Therefore, we do not recommend that you invest in stocks to achieve your short-term goals. For best results, you should invest in stocks only to meet long-term objectives that are at least five years away. And the longer you invest, the greater your chances of achieving the types of returns that make investing in stocks worthwhile.
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