Investors want lots of things, but two of them stand out above all others: They want above-average long-term returns without taking additional risk.
Fortunately, it’s not hard to get those results. First, you have to diversify beyond the familiar and comfortable S&P 500 index; second, you need patience to wait for your results, which won’t happen all at once.
If you can do those two things, history overwhelmingly shows the odds are stacked in your favor. If that seems too good to be true, I’m about to show you the numbers-based evidence.
Getting to the long term
The no-additional-risk zone seems to start at 15 years out, and I’m going to adopt that for the sake of discussion. The hard part is getting through those first 15 years.
Imagine you’re a first-time investor with a sum of money to commit for your retirement. You choose a portfolio allocation with a good long-term record, and you get started.
In the next one year, two years, five years, one of three things is likely to happen.
- Your investments might do very well.
- Your investments might have a dismal time of it.
- Maybe you’ll wind up with about the same amount you started with.
Which one it will be is a matter of luck you can neither predict nor control. If you pay a lot of attention to your early results, you’re likely to learn an unhelpful lesson.
In the first case, you could conclude that you’ve got it all figured out, that investing is easy. In the second case, you might decide the market is too risky, and you can’t stand to see your dollars vanish week after week. In the third case, you might conclude that the whole thing is relatively pointless, at least for you.
Because unexpected things always happen, many investors never make it to the 15-year mark.
Here’s a quick look at how short-term returns can be all over the map. The table compares the S&P 500 with a four-fund strategy that is equally weighted in four U.S. asset classes: large-cap blend, large-cap value, small-cap blend, and small-cap value.
Table 1: Range of compound annual returns, 1928-2022
S&P 500 index
Four fund strategy
Two years BEST
Up 41.7%
Up 49.5%
Two years WORST
Down 34.8%
Down 43.7%
Five years BEST
Up 28.6%
Up 31.4%
Five years WORST
Down 12.5%
Down 20.8%
Ten years BEST
Up 20.1%
Up 24.4%
Ten years WORST
Down 1.4%
Down 2.8%
SOURCE: Merriman Financial Education Foundation
That’s the bad news. The good news is that there’s a relatively simple way to get through this part of the journey. It was described in 1987 by Bill Gates when he was asked how often he checked the value of his stock in Microsoft
MSFT,
-2.25%.
“About once a month,” he said.
