In our last blog post, we introduced the importance of saving, which is the first of five basics that have served investors well over time. Today, we’ll look at where stock market returns really come from, and why that matters to your investing.
Before we describe where stock market returns come from, consider these two quotes:
“Whether the currency a century from now is based on gold, seashells, shark teeth, or a piece of paper (as today), people will be willing to exchange a couple of minutes of their daily labor for a Coca-Cola or some See’s peanut brittle.”
— Berkshire Hathaway Chairman Warren Buffett
“Whenever you think you’ve found the key to the market, some[one] changes the lock.”
— E.F. Hutton & Co. Founder G.M. Loeb
So, which is it? Are market returns driven by the inexorable wheels of commerce, as Buffett’s quote suggests? Or do the market’s mysteries remain under lock and key?
The answer is yes—to both. Capital markets and market returns are concurrently robust and random. It’s up to us to accept both, and invest accordingly.
Viewing the market’s daily frenzy, it’s easy to forget where all that action is coming from to begin with. Close up, markets are a messy mash-up of companies, industries, sectors, and regions, often locked in fierce competition. But take a step back to view the whole. In aggregate, the stock market is also a forum for capitalizing on our collective ingenuity, which has generated amazing advances as well as strong investment returns over time.
This is at least the case for those who have been there to capture the returns when they occur. Examples abound to illustrate how often we may feel as if a source of returns has played itself out, only to find ourselves immersed in a fresh wave of entrepreneurs who have just begun to innovate. As Dimensional Fund Advisors’ Weston Wellington points out: “Sticks and stones led to hammers and spears, the wheel and axle, the steam engine, and eventually semiconductors and jet aircraft.”
Here’s how the late, great Vanguard founder John “Jack” Bogle described it:
“If you own the stock market for a lifetime, you get those returns. Playing games in the stock market, over every day of that time, is playing the stock market. The stock market game is rigged, the business of investing is not rigged.
Even as global enterprise continues to amaze us, it usually does so in a random walk. While you’ll almost always find handfuls of remarkably winning investments at any given time, you’ll also encounter bucketloads of losers. Moreover, the winners and losers can trade places on an unpredictable dime. As Dimensional’s Wellington observes: “The benefits of innovation are widely dispersed throughout the economy, often in unpredictable ways.”
Medical advances still playing out in response to the COVID pandemic are a recent example of both the powers and pitfalls of investing in global innovation. As described in this Canadian news piece, the pharmaceutical industry broke speed records in developing the COVID-19 vaccine in less than a year. The fastest prior vaccination was to protect against mumps in the 1960s. It took four years to develop. Creating a defense against Ebola took more than 20 years.
The relative success of the COVID vaccine was probably due in part to an urgent, “all hands on deck” mindset. But it was also thanks to years and years of unheralded research and development that gave the most recent breakthroughs a huge head start. While these earlier advances undoubtedly entailed ample time and money, they may or may not have richly rewarded investors at the time.
It might help to think of the market as a mighty vehicle, like a train. When you climb aboard, your goal is to reach your desired destination by accumulating miles, or market returns, without derailing along the way. For that, you need a solid, Buffett-style engine of global commerce. But that engine also needs a supply of combustible fuel.
This illustrates why markets will always be messy and confusing at a close-up view. Only as we zoom out can we track our progress, in the shape of an upward line of market returns over time and across the long haul.
Because we expect the engines of ingenuity to continue chugging along, we have every reason to remain optimistic, and to stay invested as planned. We also understand why diversification remains equally essential to our efforts—because we never know just where the next sparks are going to fly.
By embracing the reality that stock market returns are random and robust, you can boost your ability to remain calm (or at least calmer) during the maelstroms, and improve your chances of reaching your investment goals over time.
In our next post, we’ll discuss Back to the Investment Basics Part 4: The Price You Pay Matters.
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