Guess What? Capitalism Works and You Are Owed a Return

Investing

Feb 16

Written By Jogoh

Companies and countries have used markets for years to raise money from public investors to create economic growth and generate profits.

In return for buying an ownership in a company or lending money to it, investors receive a return which compensates them for the risk that they are taking in the event that the company or country defaults on its obligations.

However, what investors must be aware of is that not all companies are the same, and likewise for countries. Some companies are inherently riskier due to the nature of their business or type of management. As such, investing with a narrow scope exposes an investor to higher risks as the likelihood that he or she is holding on to one or a few bad eggs is higher.

Why we say capitalism works is that the value of the stock market is much higher today than it was 100 years ago. Despite the ups and downs, economic crises, wars and other scary moments, investors who had stayed the course would have made a profit.

We have an example on the US total stock market below. The reason why we use this dataset is that it is very accurate (data from CRSP — The Center for Research in Security Prices), and has one of the longest running histories compared to other stock markets around the world.

We looked at the calendar year since 1926 and charted all the occasions where investors would have lost 10% of their capital or more. Surprised? Such crises have happened with a regular occurrence, not to mention the other occasions where investors ended negative but not as high as -10%.

Here is the comforting part: despite all these big losses that investors have suffered throughout the years, $1 invested at the beginning in 1926 would have become $4,399 by the end of 2015 — a stunning result from compounding.

Let’s add another fun fact. If you invest in the stock market, then you are owed a return, plain and simple.

We meet many investors who claim to be doing well with their own investments — typically mentioning that their personal stock holdings frequently make around 5% per annum.

Well, guess what? These investors are actually underperforming the market. It is great if you are making 5% this year, when the stock market is down -20%, but it is not great if you are making that 5% when the stock market is up 30%.

So, what do we mean by "you are owed a return"? For the risk you take for investing in the stock market over very safe 1-month government bills, you are compensated with an average return of 8.06% over time.

That means any investor getting a long-run return of less than 8% is being fleeced out of that return, either by investing wrongly or in something very high cost. Whilst the chart also shows that premiums do go up and down (some years the stock market loses money), nearly 70% of the years have been positive.