This is the 10th instalment of our retirement series. In my previous writings, I shared how I used our proprietary tool “RetireWell” to give our client David (aged 59), a reliable income stream throughout his retiring years. I also shared about how in holistic retirement planning, it is not just about having enough wealth, but also having a purpose-driven retirement life. (You can read the unedited version of the earlier articles at www.providend.com/articles/ ).
I have also written in part 7 of this series, about how if retirees stay invested in a broadly diversified portfolio of stocks over the long term (more than 10 years), their portfolio will grow because stock markets always rise in the long run. I have shown the data supporting this in part 7 of this series. But why do stock markets always rise in the long run?
When we invest in the stock markets, we must know that we are investing in real businesses. Fundamentally speaking, it is ultimately the earnings of these businesses that drive stock prices. And as long as there is a growing demand for goods and services, these businesses as a whole will continue to grow in their earnings. But what will cause demand to increase? The answer is population growth and rising standard of living.
Chart 1: World Population Growth
As you can see from chart 1, world population has been growing all this while and will continue to grow into 2050. And as population grows, there is an increase in demand for goods and services. The human race is also such that there will always be a desire to increase our standard of living. Both of these factors will cause consumption to always go up over the long run and businesses collectively will do better.
But of course, from time to time, there will be periods where consumption may drop and thus affect businesses and thus their stock prices. These periods are either due to business cycles (where there is a mismatch between consumer demand and supply of goods and services by businesses) or occasional unexpected events such as wars, terrorism, fear of an epidemic and so on, that caused consumers to be fearful and as such reduce consumption. But when the business cycles correct itself (and they do!) and when consumers’ fears subside and demand for goods and services return (and they do too!), business earnings return and the stock markets rise again.
Chart 2: MSCI World Index
However, you may ask, “some companies may not survive during these periods and can become bankrupt, right? How do I then choose the stronger businesses that will not?”. The answer is found in the indexed fund. When you invest in an indexed fund like the S&P500 or even the Straits Times Index (STI), you automatically invest in the strongest companies at that point in time. Yes, these companies might still not do well in the future. And if that happens, they will be replaced from the index with companies that are stronger than them. Even if they go bust before they are replaced, because you are so diversified, you are not going to be badly affected. As such. as a whole, the stock markets always rise over the long term as can be seen in chart 2.
Once you understand the above, you
- Realize that not only it is difficult to guess when exactly will stock market rise or fall, there is no need to do so, if you are investing for the long term
- Begin to understand why most people, even professionals can’t correctly guess where markets are headed, and even if they do, they can’t get it right consistently. (I have shown this to be a fact in part 3 of the series)
- Do not need to be fearful of short term fluctuations of the stock markets but just stay invested for the long term.
Table 1: Portfolio Returns from Jan 2016 to Aug 2017
Table 1 showed 2 of the indexed-based portfolios that we have invested for our retiree clients since January 2016. During this period, there were plenty of predictions that markets will do badly because of Brexit as well as the US elections. At the same time, since last year, a lot of investors have also stayed at the sidelines because they felt that equities have become expensive and will “correct” any time soon. So, what did we do to achieve the above returns? We simply avoided guessing and stayed invested and coached our clients to stay invested. Even if the markets start to fall next week, either because of reasons due to business cycles or a war has broken out between North Korea and the US, we will not be perturbed. This is because, over the last century, despite of the fact that the world has gone through 2 world wars, a great depression, the Spanish flu that collectively have killed 100 million people. And although we have experienced the Hong Kong flu, the oil crisis, the Asian financial crisis, the tech bubble, terrorism like we never experienced before. And closer to home, even though we have seen SARS, H1N1 virus attack and the Great Financial Crisis in 2008, the stock markets have continued to rise.
“But this time is different”, is a common remark we always hear from doomsayers. Of course this time is different! History has shown us that almost every time the markets tumble, it was due to different reasons. But the one thing that remains the same throughout history and will remain the same going into the future is this: As long as the world population continues to grow, and there is continuous demand for goods and services, businesses collectively will do well and stock markets will always rise.
The writer, Christopher Tan, is Chief Executive Officer of Providend, a Fee-only Retirement Financial Adviser. Besides being financially trained, he is also an Associate Certified Coach with the International Coach Federation. The edited version has been published in The Business Times on 30 September 2017.