From a distance, the stock market can look like a untameable, wildly unpredictable, scary beast.
Almost, like a sophisticated version of the roulette table. Toss your money in, place your bets, and hope for the best.
This is exactly the way I viewed the stock market before I became more familiar with it. It felt so foreign to me. I didn’t really understand how to invest my money or what my money was invested in. It felt extremely scary to risk my hard earned money on “a bet”.
What I learned over time is that the stock market can actually be wildly predictable, depending on what angle you view it from.
Before we go any further, I think it makes sense to clear up what I mean when I say “The Stock Market”. For the purposes of simplicity, I am referring to the S&P500, because it’s one of the most famous stock market indexes in the world.
The S&P500 stock market index tracks the performance of the 500 largest companies in America. The Apple, Facebook, Googles of the world. It essentially gives you an indication of how the US economy as a whole is performing on a daily basis.
Regular everyday people like you and I can invest in the S&P500 and buy shares of the entire stock market index. That means we own a tiny sliver of all 500 companies traded in that index.
Each country has their own version of the S&P500. Their “main” stock market index.
For example, in the U.K it’s the FTSE 100, which tracks the performance of the 100 largest publicly traded companies in the UK.
So when people say “The Market” is up or down, they are usually referring to one of these main stock market indices.
Unlike individual company stocks, which can go up forever, stay flat forever, or plummet into bankruptcy, the S&P500 stock market index has a magical secret:
It always goes up over time, despite many (and I do mean many), short term setbacks.
To the trained eye, there are two invisible forces at play behind the scenes that allow this to happen, as well as a whole lot of historical data to back it up.
Promotion & Relegation
If you are familiar with the world of football (the good English kind), you will understand this system right away!
If not, don’t sweat it, I’m going to break it down for you.
The stock market has little patience for slackers, so it has a promotion and relegation system built into it. What the means is that the S&P500 is reviewed regularly, and the worst performing companies are removed or dropped from the stock market index and replaced with new, better performing ones.
The best example of this in modern day is in 2020 when Tesla was added to the S&P500 and Apartment & Investment Management was given the boot.
In essence, the stock market is self cleansing in nature. New blood replaces old dead wood.
If you look back 30 years, companies like Amazon, Facebook or Google didn’t even exist. They certainly weren’t part of the S&P500 index. Today those companies dominate the S&P500 index and are the most profitable in the world.
I am sure in another 20-30 years, there will be companies that dominate the S&P500 index that don’t currently exist today.
Limited Downside, Unlimited Upside
The second invisible force that pushes the stock market up over time is that companies have limited downside, but unlimited upside.
Do you remember Blockbuster? The movie rental company.
In 2010, they famously filed for bankruptcy after laughing Netflix out of the boardroom a decade earlier.
Now, if you had left your money invested into Blockbuster until the bitter end, you would have lost 100% of your money. It’s impossible to loose more than 100%. There is a limited downside to your investment.
100% of it!
However, if you look at how Netflix stock has performed over the past decade, there is no limit to the companies upside.
In 2010, Netflix replaced the New York Times on the S&P500 index.
At the very moment of writing this blog post, Netflix stock is up +5,000% in the past decade. It has been the best performing stock on the S&P500 in the past 10 years.
There is a limit to Netflix’s downside, 100%. But there is no limit to Netflix’s upside.
Think about those two forces happening simultaneously.
- Bad performing companies are dropped from the S&P500 and replaced with new, better performing ones
- If a company is introduced into the S&P500, there is no limit to the companies upside
On top of that, our society is constantly making incredible technological progress and business are becoming much more efficient.
All these factors contribute to why the stock market always pushes up over time.
Zoomed in vs Zoomed out
It seems too easy right?
If everyone knows the stock market goes up over time, why does it feel so risky? Why do people loose money? Why isn’t everyone getting rich all the time?
The answer is that in the short term ride is extremely turbulent.
It’s not like the stock market goes up in one direction peacefully forever.
Far from it!
There are constant short term dips, drops and crashes.
It’s scary, they are sudden, and your portfolio can loose a lot of value in a short period of time.
There are infinite reasons why the stock market can crash. A slow economy, a new president, interest rates, a bad headline, housing markets, war, famine and disease, oil prices, international sanctions, currency drops, or a f@&£*$^ tweet by Donald Trump or Elon Musk, and on and on.
These drops happen on a regular basis, but you can never predict when they are going to happen. That is what makes the stock market feel so risky.
In these moments, it’s important to remember how resilient the stock market actually is.
Take a look at these images of the S&P500.
They tell a very different story, depending on how you view them.
S&P 500 in the past 5 days (Feb 19 - Feb 24)
Ok. Things are not looking very good for you!
If you had investments in the S&P500, you would be down almost 6% in the last 5 days.
It’s important to understand what is happening in the world at this moment in time.
Russia is at war with Ukraine, the worst conflict in Europe we have seen since 1945. This is an impact on energy and oil prices (Russia is the main supplier for Europe). Translating to larger operating costs for businesses, potentially damaging costs for some who cannot offload to the consumer. As such, the market has dropped.
However, 5 days is a very short window of time to analyse. How about the past 6 months?
S&P 500 in the past 6 months (September 2021 - Feb 2022)
For the past 6 months, the S&P500 has yo-yoed up and down.
During this time period you would be down -7% on your investment in the S&P500 index.
Inflation is on the rise, interest rates are increasing, and the cost of living is set to follow suit. People are cutting back on spending their hard earned cash on “luxuries”.
The stock market is pessimistic about the economy and therefore your returns are down.
In the world of investing, 5 days and 6 months are both examples of very short term views.
Lets zoom out and view the S&P500 performance over the past 5 years. I would consider this a medium term view of the stock market.
S&P 500 in the past 5 years (2017-2022)
Wow! A totally different story.
Your investments are up almost 80%. You are close to doubling your money in just 5 years.
If you invested £50,000 in the S&P500 in 2017, your investment would be worth £88,500 today, despite the recent short term poor performance we just saw above.
Good investing is always done over the long term. I’m talking 20, 30, 40 years.
So let’s zoom out one more time and take a look at the S&P500 since 1982 and see if the market always goes up...
S&P 500 in the past 40 years (1982-2022)
Were there some setbacks along the way?
The most notable in our era is the 2008 global economic crisis which was triggered by the housing market collapse. It’s the single worst market crash in history since the Great Depression.
Can you find it?
It’s the dip you see right before the market explodes upwards for the next decade.
Over the last 40 years, your investments would be up +3,598.25%.
So that original £50,000 investment in the S&P500 index in 1982 would be worth close to £1.7m today
In the short term, the stock market looks incredible volatile and unpredictable. That’s because it is.
However, when you zoom out and take a 20, 30 or 40 year view of the stock market, it’s amazing how predictable it really is.
Drips, crashes and corrections are all part of the natural ebb and flow of the stock market. It’s completely normal.
They happen regularly and we need to get comfortable with them. Otherwise our emotions are going to yo-yo up and down through our entire investing career, based on what is happening in the present.
It’s important to remind ourselves how resilient the stock market is.
Once we truly understand how the stock market works, the powerful forces at play, and why it always goes up, we can start to become resilient investors.
No matter what is happening in the world around us.
❤️ Patrick & TOMII Tribe
What We're Listening to 🎧
The Mad Fientist - The Importance of FU Money
If you are interested in Financial Independence and you have never tuned into The Mad Fientist, you are missing out! Brandon hosts one of the most popular podcasts in the Financial Independence community. FU money is a popular term which essentially means the more wealth you build and the less debts you have, the more power you have to say “FU” to things you don’t want to do. Enjoy :)
What We're Doing 🤩
We built our new website → www.tomiitribe.com
It’s brand new and we love how it looks 😍
What do you think?