We haven’t written about Chinese markets since our epic post comparing social and political reactions to the market fall in China and recent American market falls. We wanted to touch on it again because of a universal truth which needs to be told again: if you’ve got a short time-frame, or if it’s stability you need: don’t depend on stocks.
Safety, Risk, and the Risk of Not Having Enough
At issue (or reminding us of the issue), an interesting quote in a New York Times article way back from July 6th, entitled “Chinese Investors Who Borrowed Are Hit Hard By Market Turn“:
“I don’t need a high-flying market, just a stable one,” Mr. Gong said.
Not to pick on Mr. Gong, since his quote undoubtedly summarizes the feelings of many investors (and it’s already a month old!), but a rapid decline in the market isn’t the only sign of volatility – a rapid unexpected, unsupported by fundamentals rise in the market is also a sign of market instability. Just like deceleration (say, hitting your breaks) is really still an example of acceleration (a change in speed over time), rapid rises are also an example of volatility. Rises are just, you know, a market movement that people enjoy more than the flip side.
Large Returns Necessitate Risk
As a matter of fact, it’s the large rises and falls themselves which allow the stock market to have larger average returns than other asset classes like corporate or government debt. It’s debt issuance which is the more stable class – ignoring the risk of defaults and bonds being called, the exact return of debt held until maturity is known up front. That is to say: if you buy 30 year Treasury debt, you can be pretty sure you’ll get paid what you’re owed.
Stocks don’t work the same way. When you buy shares of a company, there is no guarantee you’ll get any sort of return over some holding period. Yes, there might be share buybacks and dividends while you hold the shares – but there is no guarantee that your total return will be any particular amount, let alone positive. All we can say with certainty is that over a long period of time, a large basket of stocks in the US (like the S&P 500) averages something like a 6.5% return after inflation. And, yes, you can subtract things like taxes and fees from that number – and, yes, you will see huge swings in returns in any given year… or longer.
Don’t Depend on Stocks but Recognize The Risk of No Risk
Of course, avoiding stocks entirely isn’t a good option – especially early in your career.
While there is a definite risk to stock purchases, there is an even bigger risk in your portfolio – the risk that you won’t have enough resources at retirement. Unless you save an incredible percentage of your income (or we go through a different era for investing!), investing in solely ‘safe’ assets like bonds will leave you short at retirement. You really want to have risky assets such as stock over a long period of time – enough time that the generally positive drift rate of stock overcomes any temporary moves to the downside. That may take a very long time, and some levels may never be breached in your investing timeframe (PDF warning) – but your best chance, so to speak, is to invest in relatively risky assets.
So, paradoxically, there is a risk of not taking on enough investment risk, just as there is a risk of taking on the risk itself. There are no guarantees in life, but unfortunately for investors in China and elsewhere, it’ll take a bit of risk and perhaps a bit of luck to realize a comfortable retirement.
So, where do you stand? Are you taking on risk, or risking you retirement with not enough risk? Is our “don’t depend on stocks” warning good for your time-frame and temperament today, or do you disagree?