Stocks — Part II: The Market Always Goes Up

 Avoiding panic when it is raining stock brokers ain’t easy

On what was later to be called Black Monday, in 1987, at the end of a very busy day I called my broker.  Remember now, this was when we had brokers and before cell phones, personal computers, the internet and on-line trading.

“Hi Bob,” I said cheerfully.  “How’s it going.”

There was a long silent pause.  “You’re kidding,” he said.  “Right?”  He sounded dreadful.

“Kidding about what?”

“Jim, we’ve just had the biggest meltdown in history.  Customers have been screaming in panic at me all day. The market is down over 500 points.  Over 25%.”

That was the point at which I joined the rest of the planet in being absolutely stunned.  It is hard to describe just what this was like.  Not even the Great Depression had seen a day like this one.  Nor have we since.  Truly, it looked like the end of the financial world.

Time Magazine, 1987

Wrong

As any educated investor does, I knew that the market was volatile.  I knew that on it’s relentless march upwards there could and would be sharp drops and bear markets.  I knew that the best course was to hold firm and not panic.  But this.  This was a whole ‘nother frame of reference.

I held tight for three or four months.  Stocks continued to drift ever lower.  Finally, I lost my nerve and sold.

I just wasn’t tough enough.  That day, if not the absolute bottom, was close enough to it as not to matter.  Then, of course and as always, the market began again its relentless climb.  The market always goes up.

It took a year or so for me to regain my nerve and get back in.  By then it had passed its pre-Black Monday high.  I had managed to lock in my losses and pay a premium for a seat back at the table.  It was expensive.  It was stupid.  It was an embarrassing failure of nerve.  I just wasn’t tough enough.

But I am now.  My mistake of ’87 taught me exactly how to weather all the future storms that came rolling in, including the Class 5 financial hurricane of 2008.  It taught me to be tough and ultimately it made me far more money than the education cost.

Here’s the thing you need to understand:

The market always goes up.

Always.  Bet no one’s told you that before.  But it’s true.  Understand this is not to say it is a smooth ride.  It’s not.  It is most often a wild and rocky road. It’s not easy.  Reader JTH in the comments for Part I says:

“We’ve stayed the course, with a side-dish of panic.”

Great line there JTH, and staying the course is always served with a side dish of panic.  That’s why ya gotta be tough.

Because the market always, and I mean always, goes up.  Not each year.  Not each month.  Not each week and certainly not each day. But relentlessly up.  Take a moment and look at this:

The Dow Jones Industrial Average 1900 – 2012

Can you find my ’87 blip?  It’s there and easy to spot, but not quite so scary in context.  Take a moment and let this sink in.  You should notice three things:

1.  Trend is relentlessly, thru disaster after disaster, up.

2.  It’s a wild ride along the way.

3.  There is a Big, Ugly Event.

Let’s talk about the good news first.  We’ll tackle points 2 & 3 next time.

To understand why the market always goes up we need to look a bit more closely at what the Market actually is.

The chart above represents the DJIA (Dow Jones Industrial Average).  We are looking at the DJIA because it is the only group of stocks created as a proxy for the entire stock market going back this far.  Way back in 1896 a guy named Charles Dow selected 12 stocks from leading American industries to create his Index.  Today the DJIA is comprised of 30 large American companies.

But now let’s shift away from the DJIA Index, which I only introduced for its long historical perspective, to a more useful and comprehensive Index:   MSCI US Broad Market

If you click on that link it will take you to a article announcing that Vanguard is using this Index in crafting the Vanguard Total Stock Market Fund (VTSAX).  (Update: As of June 3, 2013 VTSAX is now using the CRSP US Total Market Index)

The Index and VTSAX are exactly what they sound like:  Groupings of every publicly traded US based company. By design they are almost precisely the same.  Since we can invest in VTSAX, going forward I’ll be using it as our proxy for the Stock Market overall.

In 1976, when John Bogle invented the Index Fund he gave the world a wonderful way to invest in the entire US Stock Market.  This is the single best tool we have for taking advantage of the market’s relentless climb up.  VTSAX is the market and as such does the exactly the same.

OK, so now we know what the stock market actually is and we can see from the chart that it always goes up.  Let’s take a moment to consider, how can this be?  Two basic reasons:

1.  The Market is self cleansing.  

Take a look at the 30 DJIA stocks.  Care to guess how many of the original 12 are still in it?  Just one.  General Electric.  In fact, most of these companies didn’t exist when Mr. Dow crafted his list.  Most of the originals have come and gone or morphed into something new. This is a key point:  The market is not stagnant.  Companies routinely fade away and are replaced with new blood.

The same is true of VTSAX.  It holds virtually every publicly traded stock in the US market. A little over 3000.   Now, picture all 3000+ of these companies along a classic bell curve graph.

Generic Bell Curve Graph

Those few at the left will be the worst performing.  Those few to the right, the best.  All those between at various points of performance.

Ok, looking to the left what is the worst possible performance a bad stock can deliver?  It can lose 100% of its value.  Then, of course, it disappears never to be heard from again.  As new companies grow, prosper and go public they replace the dead and dying.  The Market (and VTSAX as proxy) is self cleansing.

Now let’s look at our top performers on the right.  What is the best performance they can deliver?  100%?  Certainly that’s possible.  But so is 200, 300, 1000, 10000% or more.  There is no upside limit.  As some stars fade, new ones are on the rise.

The net result is a powerful upward bias.

But note, this only works with index funds.  Once “professional management” starts trying to beat the system, all bets are off.  They can, and most often do, make things much worse and they always charge more fees to do it.  We’ll talk a bit more about this in a later post.

2.  Owning stocks is owning a part of living, breathing, dynamic companies, each striving to succeed. 

To appreciate why the Stock Market relentlessly rises requires an understanding of what we actually own with VTSAX.  We own, quite literally, a piece of every publicly traded company in the USA.

Stocks are not just little slips of traded paper.  When you own stock you own a piece of a business.  These are companies filled with people working relentlessly to expand and serve their customer base.  They are competing in an unforgiving environment that rewards those who can make it happen and discards those who can’t.  It is this intense dynamic that make stocks and the companies they represent the most powerful and successful investment class in history.

So, now we have this wonderful wealth building tool that relentlessly marches upward but, – and this is a major but that causes many if not most people to actually lose money in the market – boy howdy it’s a wild and unsettling ride.  Plus, there’s that Big, Ugly Event.  We’ll talk about those next.

Disclaimer:  Like everything on this blog, this is only sharing ideas.  You are solely responsible for your own choices.

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27 Comments

  1. bluecollarworkman
    Posted April 19, 2012 at 8:57 pm | Permalink

    I know this is obvious, but I have to say it anyway. I completely agree with your premise here and you’re obviously quite correct. But. If I was 50 years old in 1928 and looking to retire in a decade and had my money in the market. Well, it would be 3 decades after that crash before my money would get back to it’s 1928 value! I would be 80 by then. Or actually probably even dead.That’s pretty rough. For young investers, yeah, be bold and don’t freak the frack out, STAY IN! But for older investers, they do need to be more careful!

    • Posted April 19, 2012 at 10:22 pm | Permalink

      You are right on target there, BCW….

      …that’s the Big, Ugly Event. I’ll have more to say on that coming up.

    • Dan
      Posted September 13, 2013 at 10:06 am | Permalink

      Hi, I actually have had this conversation with my 60 year old boss about his bad investments made in 2000 right before the crash. If you were unfortunate enough to wish to retire in 1928, and continued to dollar cost average into the market for a few more years, my guess is you would have incredible returns. That’s part of being “tough.” Also, it’s doubtful you would have chosen one day to invest ALL of your money in the stock market in 1928. Thus, most of your gains would have been paper gains anyways and the amount of capital vs. losses would be very little given how many years you would have been investing already (say since 1900).

      Dan

  2. Fuji
    Posted April 20, 2012 at 4:53 am | Permalink

    I love your writing – a calm oasis of steadiness amongst the grating backdrop of shrill media. Thank you for sharing your wisdom. :)

  3. JTH
    Posted April 21, 2012 at 11:33 am | Permalink

    Thanks. This is reassuring. As BCW says, what about the 50+ investors? When and how do they gracefully bow out of the drama? We’ve saved, diversified, and when the side-dish of panic comes along, it rocks our boat big time. (JTH not JYH …). These articles are great and understandable for us novices. Thank you. Can’t wait for next episode.

    • Posted April 21, 2012 at 4:10 pm | Permalink

      Hi JTH….

      Stay tuned. We’ll be discussing death building and wealth preservation phases coming up.

      Thanks for the name correction.

  4. Posted April 21, 2012 at 12:46 pm | Permalink

    I don’t entirely consider myself a “novice” investor, but I am learning from some of your writing like this post. Some of that background information on the origination of the DJIA is news to me. Glad you posted it, because I would have never taken the time to research it otherwise. Thanks.

  5. Posted April 22, 2012 at 1:31 am | Permalink

    Great article Jim. I agree with you that index fund is — by far — safest way to make money. I also agree with you that markets always go up in the long run. As you’ve mentioned, many stalwarts of past have faded. So, anyone who is investing in a specific stock has to be vigilant as I do. You can’t assume that GE will last forever(although I believe it will). :)

    • Posted April 24, 2012 at 11:46 pm | Permalink

      Thank you!

      Not only is an Index Fund – VTSAX – the safest way, it is the easiest way as well. Plus over time it will out perform 80+% of professional stock pickers. Slam dunk.

      As you point out, investing in individual stocks requires a whole new level of commitment and vigilance. Even then the odds are heavily against you:

      http://jlcollinsnh.com/2011/06/02/why-i-cant-pick-winning-stocks-and-you-cant-either/

      as for GE, who knows. They had a surprisingly close brush with disaster a couple of years back thanks to what had been their profit leading GE Capital Division.

      Now Apple is the current darling and soon to be the first Trillion dollar company. I dunno and haven’t done any analysis. But talk like that is enough to make me nervous.

  6. Posted May 28, 2012 at 5:09 pm | Permalink

    The market always goes up, but if you invested in 1929 you had to wait 30 years for it to do so. What if someone decided to get into investing in their 60s? They might not have had 30 years to wait…

    We can’t all invest in VTSAX. Any suggestions for international investors?

  7. Matt MF B
    Posted June 4, 2012 at 1:20 pm | Permalink

    http://www.cnbc.com/id/47668274/Tokyo_Hits_28_Year_Low_Amid_Global_Rout

    You may be right about markets eventually always going up but the wait can be a disaster, witness this story that came out this weekend. Tokyo broad stock market averages at the lowest point in 28yrs. You could very well die before your basket of stocks return to previous levels. If you need to have money to live on the long term (not just the short term) market trends can leave you broke. It’s a little cavalier to think that just because the past 100 years the market’s always gone up that it will continue to do so for the next 100 years. It’s also potentially a disservice to your readers. Go ask an ancient Roman if ingenuity can sustain a prosperous civilization in perpetuity.

  8. MrRob
    Posted November 13, 2012 at 8:46 am | Permalink

    Hi Jim, I’m a 29yr old UK based reader, relatively new to your blog (found it from MMM) and am currently undergoing what I call a financial revolution and what my wife calls a financial crisis.

    I appreciate you sharing your wealth of wisdom and experience here, its life enriching stuff. I have really enjoyed reading your blog and have been inspired to start this financial revolution, which basically involves having a plan and choosing to aim for financial independence.

    I’ve been incredibly lucky to have been a financial broker in some incredibly strong markets and made a decent amount of money at a young age. However, it does feel strange to know that I earned the most I ever will in my life at the age of 26 and since then it’s only been decreasing each year.

    Going forward I’m fortunate enough to be able to save a good proportion of my high salary into tax free ISAs (like your IRA Roth with maximum £22,500 per married couple per year) and have a company pension (like your 401/403 plan). I have a few years of this already squirrelled away, plus I’ve been quietly loading my company pension (I contribute 5%, the company contributes 10% of my salary). I don’t get much choice for where I invest my pension, so I choose a cheap to maintain global tracker fund (50% UK stocks and the rest spread across the globe).

    However for my ISAs I get to choose whatever I like and this is what causes most of my questions/confusion. Plus I actually have about £50k investment grade art, and £11k physical gold, a house with a mortgage (for me, my wife and my daughter) and am just embarking on investing in an apartment (mostly to help out a close friend).

    Currently my wealth building assets that I have control over are the art, the gold and the stocks and shares ISAs (worth £100k). You will cringe but currently the ISAs are invested with a stock broker in a mixture of equity funds, high yield individual stocks and I have a corporate bond too. Some of these funds cost me 5% to get into and have annual fees of 1.75%, others cheaper but in any case this causes me concern and I’m now keen to pursue cheap fees going forward. And it’s this stuff, plus my on going ISA contributions that need some consideration. I loved reading your Stocks series and have read all 12 pages probably 3 times through now.

    I think the thing I loved most is your certainty. When I live in a very uncertain world and consume lots of opinionated information to try and find the right path, you present a very simple way forward that you seem certain will produce the desired result – capital gains at some point in history. I understand some of your views but still have questions about others.

    I like Vanguard for obvious reasons, I like low cost investment, I like the self-cleansing index, I like starting early, I like compound returns over time, I like the idea of heavy lifting investments (equities) however there is something stopping me taking the plunge from my current situation (chosen by my financial advisor – graduate in a suit who talks well and convinces me that the themes we are picking make sense and should outperform in the long run – oh how you laugh). Essentially I just don’t know if I trust equities enough to go all in.

    Many times I’ve read that ‘most of the gains over the last 100 years in equities have been due to dividend reinvestment’. I think this is an interesting statement. That basically says to me that compounding is the key to wealth growth. As long as you get a yield from your investment, and start early then (not including inflation or deflation) you’ll make your money from the effect of compound growth. I happened to see an article the other day from The Sunday Telegraph by a guy called Toby Nangle (I mention these so you can Google the article if interested) that showed a graph showing real returns from UK equities from 1700 to present. Real returns being inflation adjusted without dividend reinvested. It claims that the real returns from equities were low from 1700 til 1970 and from 1980-2000 they boomed and that we can’t expect that bull run again.

    This makes me question whether stocks are actually the eternal heavy lifter that you paint them to be or whether we could retreat to decades or centuries (not that I care) of limited real returns?

    When I first read your Stocks series I was very convinced about a lot of your arguments, and I was elated that I had a found a plan to long term wealth building. After rereading, digesting, being blasted by conventional wisdom there is still a lot I like and agree with however it’s the certainty that stocks are the way forward that I find difficult. I’m not sure if I trust them long term.

    If I was ultimately convinced of this, I reckon I could go all in and buckle up for the rocky ride but currently I’m paralised in my current situation. I trust in starting early, I trust in low cost investments, I trust in tax efficient wrappers, I trust in compounding over time, however I’m not sure I trust in equities . . .

    Any comments, thoughts, advice or recommended reading material would be much appreciated. Another thing that may shape an answer and is maybe part of my distrust is that I’d rather work my socks off for 10-15 years and save 70% of my salary with a lower cost lifestyle to give us some form of financial freedom . . . rather than wait 20, 30, 40, 50 years for equities to be booming again. Apologies to all readers for such a long post.

    • Posted November 22, 2012 at 9:30 pm | Permalink

      Sorry for the delay in responding. I just got back from South America and am just now catching up.

      Hi Mr. Rob….

      Your comment brought a smile to my face for a couple of reasons.

      1. It is always a pleasure to read the stories of young people like yourself who are so well on their way to FI. Given how far you’ve already come I can only marvel at how far you’ll go.

      2. With your comments like “You will cringe..” and “oh how you laugh” clearly you’ve read my stuff well enough to know what I’d say. :) So I won’t address those issues, you already know what to do.

      You also say: “This makes me question whether stocks are actually the eternal heavy lifter that you paint them to be or whether we could retreat to decades or centuries (not that I care) of limited real returns?” My answer is in the post at the very end under point #2 in the second paragraph:

      “Stocks are not just little slips of traded paper. When you own stock you own a piece of a business. These are companies filled with people working relentlessly to expand and serve their customer base. They are competing in an unforgiving environment that rewards those who can make it happen and discards those who can’t. It is this intense dynamic that make stocks and the companies they represent the most powerful and successful investment class in history.”

      And I would add that this is happening on a global basis. Past decades and centuries long retreats were tied to the collapse of countries that had their economies far more islolated. Now, businesses simply shift operations. Unless you think the dynamic I describe in that quote will dry up, stocks will continue to be the heavy lifters.

      You say you are not sure if you can trust stocks. Of course you can’t trust them. If you are not very careful, tough and long-term focused the moment you panic they’ll cut your throat and leave you to bleed to death in the dirt. It is not about trust, it is about understanding the relentless drive upwards and the violent volatility along the way and then adjusting your own psychic toughness to ride the bucking bull.

      You say “I’m paralised in my current situation.” You’ve obviously been reading a lot about this stuff and that’s good. But you’ve also discovered conflicting information. Only you can sort thru what makes sense for you. You need to read my stuff, and others, with a critical mind asking if what is said makes sense. Before you follow my advice, or any other, be sure you fully buy into it. Otherwise, the next thing you read will pull you into yet another direction and that vacillation is a sure path to failure.

      Finally, if you implement a 70% savings strategy you are doing something far more powerful than choosing the optimal investment strategy. Do both and, well as I said, I marvel at how far you’ll go.

      Good luck and stay in touch!

      • MrRob
        Posted November 23, 2012 at 7:05 am | Permalink

        Hi Jim,

        Many thanks for your reply and affirming words. I very much agree on your closing statements about exploring more and acting on something I have conviction about. Its never good to be blown around by the latest trends and chopping/changing all the time is expensive and draining.

        A perfect analogy would be diet. About 9 months ago I became deeply convicted that there was merit in paleo-esque diets (and associated exercise) after reading a number of books including The New Evolution Diet by Art De Vany. Since then I have completely changed what I eat, am much healthier and happier about it and irrespective of what conventional wisdom I get thrown at by the world’s media or my grain loving colleagues I maintain that I will probably never deviate off this diet for the rest of my life as I believe its the right way to go.

        I need that conviction about investing and personal finance in the same way. Things I’m sure about are start early, save hard, try to avoid lifestyle inflation to ensure one can maintain saving and I’m working on my understanding of asset allocation and belief that equities and index tracking is the best road forwards from here.

        I had a long chat with ‘the graduate in a suit’ yesterday evening and he was maintaining that large advisory stockbrokers like them would not have customers if they weren’t able to pick the funds that out-perform their respective bench marks and help their customers avoid the dodgy ones.

        If we can’t trust anyone to consistently pick top quality stocks to outperform, then how can we trust anyone to pick outperforming funds over the long term? At the end of the day he has to say they are good at what they do and that by going with their advice and the funds they choose it will give the investor a better chance of making money over cheaply tracking the index alone. The think they add value, they certainly charge as if they add value but they probably (and you’d shout definitely!!!!!! don’t).

        One thing I still ultimately need clarity over is whether I believe a FTSE 100 (top 100 largest companies in UK) tracker or a FTSE Allshare tracker (top 650 companies) gives me sufficient exposure to all that is out there. I am aware that emerging markets should be growing quicker than mature ones and exposure to them might be worthwhile. Also some spout that Japan is worthwile investing in now and then of course the is US equity too that I could be completely missing.

        These are all themes under further consideration but I’m sure I’m making progress in some form or other so that is good enough for now. Once again thanks for this resource and your committment to it. Its great, keep it up.

        • Posted November 23, 2012 at 10:02 am | Permalink

          The comments section under Part XI of this series Working Rachel asked a similar question about adding an international fund. Here’s my response:

          “Welcome Rachel…

          ..thanks for stopping in. Great question!

          Regarding international funds you can certainly add them if you’d like. As you point out, Vanguard offers International Index Funds. They’ll serve you well.

          I don’t bother for these reasons:

          1. The US is still the dominate world economy and, in my view, will remain so for the next 100 years and counting. That dominance will shrink over time, as it has been doing since the end of WWII, but it is not ending anytime soon.

          2. VTSAX is loaded with US companies that are fully international in their operations. Indeed many generate well over half their revenue and profits overseas. So it provides exposure to expanding world markets.

          3. This trend will continue to expand as the international economies around the world continue to grow and prosper.

          4. Accounting standards and transparencies in the US remain the envy of the world. Less funny business to worry about.

          5. Direct international investing introduces currency valuations into the mix and that is a whole other level of risk that needs to be considered.

          Hope this helps!”

          While I’m not terribly familiar with what the FTSE indexes hold, my guess is it is also heavily weighted with international companies. So the same thoughts would apply.

          Oh, and large advisory brokers have been hemorrhaging customers at an accelerating pace precisely because better and less expensive options abound. If in the UK they are like those in the USA you can expect an ugly, difficult struggle prying your money back away from them. Still another reason to avoid them in the first place.

  9. Christina
    Posted March 8, 2013 at 11:52 am | Permalink

    Will a shrinking population effect this thesis? Since we are now below replacement rate there are going to be fewer and fewer young people to work in these companies and fewer families needing fewer products. For a while we’ll have a large industry for taking care of the elderly, but once they die there is going to be little to fill the void.

    • jlcollinsnh
      Posted March 8, 2013 at 8:57 pm | Permalink

      Wonderful question, Christina!

      As it happens I am a member of the infamous Baby Boom generation. There are/were about 75 million of us. The bulge working its way thru the snake, if you will.

      My daughter is a member of Generation Y, those born from roughly 1985 to 2000. There are roughly 70 million of them coming up behind us and building their own lives.

      More importantly than that, most of the developing world is very young. Think China, India, South America, Africa. Large segments of these populations are rapidly improving their economic condition and moving into the middle class.

      Consider India with 1.2 billion people. 850 million of them live in poverty. But 350 million are middle class or wealthier. That is more than the entire population of the US. Same dynamic in those other places I mentioned.

      There is a HUGE and growing population of young and increasingly wealthier people coming of age all over the world. Their expectations are growing sharply. Like people everywhere they will be keenly interested in securing their financial futures.

      This changing demographic will pose considerable challenges, environmental come to mind. But for investors it is a huge and positive wave to ride.

  10. AOG
    Posted June 13, 2013 at 5:05 am | Permalink

    Hi Jim, you mentioned the stock market always goes up / always recovers because the worst thing that can happen to a company is just lose 100% of its value but there is no limit as to how much it can gain.

    But I’m just wondering why after 21 years, the Nikkei Index 225 has not recovered. 20 years is quite a long time frame for the average investor. Is the Nikkei 225 also self-cleansing?

    What are the chances that the same thing wouldn’t happen to the US market?

    • jlcollinsnh
      Posted June 13, 2013 at 10:26 am | Permalink

      Hi AOG…

      Well of course it has happened here and could again. That is the subject of Part IV.

      Setting aside the fact that there are huge differences between the US and Japanese cultures and economies, the Japanese did almost everything wrong in dealing with their crisis.

      During our own 2008 debacle we apparently learned from their experience and our own Great Depression and did most things right. I find that encouraging.

      • Jerome
        Posted March 25, 2014 at 8:02 am | Permalink

        I have to say this is a very weak counter argument Jim. I agree with the poster who said you are a doing a disservice to your readers as the stock market does NOT always go up.

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