Investing in Equities - Is it Worth the Risk?

Consider this historical scenario.  It’s late October 2023.  The market just experienced another correction with the S&P 500 closing at a five-month low on October 27.  Year-to-date returns are back to nearly flat, and the market remains 14% below the previous high of December 2021.  At the same time, money market funds and Treasury Bill yields eclipsed 5%, offering compelling returns without the volatility of the market.  This rightfully led investors to contemplate the question – is investing in equities worth the risk? 

Flash forward two months later, and the S&P 500 closed 2023 to record its fifth best year in the 21st century.  Now annual market forecasts are coming out and pundits featured in the news make their short-term predictions (the wilder the prediction, in particular if it’s doom-and-gloom, the more publicity the prediction may receive).  With the market now close to the previous all-time highs from December 2021, the question still presents itself – should we stay invested in equities?

There are a few takeaways from this recent experience to help address that question:

1. Staying invested can unlock potential long-term market gains as big moves higher may cluster together just as often as moves lower. Take this illustration from JP Morgan’s Guide to the Markets:

Two statements were true over the last 44 years: (1) the majority of years the S&P 500 had positive double-digit gains AND (2) the majority of years the S&P 500 had at least one double-digit decline within the year.  2023 saw both events come to pass.  Investors who commit to staying invested should understand to expect double-digit market swings as the price of admission to earning potential long-term market returns.

2. Cash feels safe as it protects against portfolio swings in the short run but becomes a risk as it competes with inflation and the loss of future purchasing power in the long run.

Oftentimes, investors have a timing mismatch of risk.  They often overestimate short term risk and underestimate long term risk.  Missing out on compounding returns in order to outpace inflation may pose the biggest risk to successful long-term outcomes.  As financial professionals guiding clients through multiple market cycles across decades, we consistently find it’s not the first several years of a financial plan that keep us up at night.  Those years are often covered through some combination of work, savings, retirement income, and conservative investments outside of the market. Rather it’s the latter years of the plan that give us greater concern.  We focus on maintaining meaningful allocations to investments we expect to outpace inflation for positive real returns.  Look at the past five to fifteen years as an example:  

Benchmark returns as of 12/31/2023. The global stock market index significantly outperformed inflation over the last five, ten, and fifteen years while cash earned below inflation in the same time periods delivering a negative real return. 

Source: Black Diamond Performance Reporting. Investing involves risk, including the possible loss of principal. The discussion of indices is for illustrative purposes only. Investors cannot invest directly in an index. No investment or advisory fees are included in the above index returns.

3. We believe the single greatest portfolio value we provide is partnering with our clients to stay invested year after year to unlock the potential of long-term compounding.

As a long-distance runner, it’s easy for me to sign up for a marathon and create a training plan for the race.  The hard part is the training runs day after day, week after week, then year after year.  James Clear, author of Atomic Habits, discusses the power of identity-based habits.  Rather than having a goal to run a marathon, I identify as a long-distance runner.  It’s a part of who I am, the clothes I wear, the people I spend time with, and a core part of my weekly routine.  Likewise, we believe identifying as long-term investors is one of the most powerful wealth creating decisions a person can make.  Like this past year showed, the market can swing wildly over any short period of time.  While staying invested is easy to say; it’s hard to do.  That’s why the best athletes have a coach by their side throughout their entire careers to keep them on the path moving forward.  And that’s why we commit to partnering with our clients to keep them on the path moving forward throughout their entire financial journey.

Andy Michael, CFA
Portfolio Manager