By now the cliché of stocks being less risky in the long run has been criticized heavily. I have done my bit here, for example. But it is still common in the United States and to a lesser extent in the UK to hear that if you hold stocks for 10, 20, or 30 years, you are going to make money.

The problem just is that while you are more likely to make money, the probability that your stock market investment is going to end up in a loss after inflation remains much higher than many investors think. The main reason for this overly optimistic assessment of long-term stock market returns in the United States and the UK is the inherent selection bias when looking at these two stock markets. A group of researchers has recently re-examined the returns of stocks in 39 developed countries from 1841 to 2019 ad confirmed what many investors outside the US and the UK know for a long time: stocks are really risky, even if you hold on to them for a generation.

The tables in the note are really worth examining at length because they show the extremes of stock market returns both in the short term and in the long term. For example, the biggest monthly drop in the UK in real terms was 26.9% and in the United States 29.5%. If you think losing a quarter of your investments in one month is a lot, be glad you weren’t investing in Australia (biggest monthly decline ever recorded -42.5%), Belgium (-55.9%), Japan (-87.2%), or Germany (-91.1%). Of course, Germany and Japan suffered extreme shocks like the Second World War and hyperinflation when these losses occurred, but Australia never had any major shock and still managed to post extreme losses in some months.

If we focus on the long-term returns, the authors use the complete set of stock market returns to calculate the probability of a negative return after inflation for different investment horizons. And notably, even after 30 years, the probability of losing purchasing power with stocks is still 12.1%.

Probability of negative real returns

Chart, bar chart

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Source: Anarkulova et al. (2021).

And in this respect, the United States and the UK are truly special. In my new book on geopolitics, I explain that wars are really bad for your stock market if the war is fought on your home territory but tend to be immaterial for your stock market if they are fought elsewhere. Not having seen their home territory destroyed in any war over the last century or more has certainly provided a big advantage to the stock markets in the United States and the UK. But in general, political stability and the rule of law have helped even more. The historic experience of losses in the long run is vastly different in the United States and the UK, something that investors should keep in mind.

Probability of negative real returns after 30 years

Chart, waterfall chart

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Source: Anarkulova et al. (2021).

This brings me to the point I am trying to make here. Investors in the United States and the UK should remember that their stock markets were blessed in the past with a lack of shocks and trouble. A stable democracy, sound monetary policy that didn’t trigger hyperinflation, and a business-friendly environment all contributed to this success. But none of these things can and should be taken for granted. They can be lost at relatively short notice.

Klement on Investing

Stocks in the long run… are still risky