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103-Investing for the Long Run 
  Course 103:
  Investing for the Long Run
  In the last lesson, we noticed that the difference of only a few percentage
  points in investment returns or interest rates can have a huge impact on your
  future wealth. Therefore, in the long run, the rewards of investing in stocks
  can outweigh the risks. We'll examine this risk/reward dynamic in this lesson.
  
  
  Volatility of Single Stocks
  Individual stocks tend to have highly volatile prices, and the returns you
  might receive on any single stock may vary wildly. If you invest in the right
  stock, you could make bundles of money. For instance, Eaton Vance EV, an
  investment-management company, has had the best-performing stock for the last
  25 years. If you had invested $10,000 in 1979 in Eaton Vance, assuming you had
  reinvested all dividends, your investment would have been worth $10.6 million
  by December 2004.
  
  On the downside, since the returns on stock investments are not guaranteed,
  you risk losing everything on any given investment. There are hundreds of
  recent examples of dot-com investments that went bankrupt or are trading for a
  fraction of their former highs. Even established, well-known companies such as
  Enron, WorldCom, and Kmart filed for bankruptcy, and investors in these
  companies lost everything.
  
  Between these two extremes is the daily, weekly, monthly, and yearly
  fluctuation of any given company's stock price. Most stocks won't double in
  the coming year, nor will many go to zero. But do consider that the average
  difference between the yearly high and low stock prices of the typical stock
  on the New York Stock Exchange is nearly 40%.
  
  In addition to being volatile, there is the risk that a single company's stock
  price may not increase significantly over time. In 1965, you could have
  purchased General Motors GM stock for $50 per share (split adjusted). In the
  following decades, though, this investment has only spun its wheels. By May
  2005, your shares of General Motors would be worth only about $30 each. Though
  dividends would have provided some ease to the pain, General Motors' return
  has been terrible. You would have been better off if you had invested your
  money in a bank savings account instead of General Motors stock.
  
  Clearly, if you put all of your eggs in a single basket, sometimes that basket
  may fail, breaking all the eggs. Other times, that basket will hold the
  equivalent of a winning lottery ticket.
  
  
  Volatility of the Stock Market
  One way of reducing the risk of investing in individual stocks is by holding a
  larger number of stocks in a portfolio. However, even a portfolio of stocks
  containing a wide variety of companies can fluctuate wildly. You may
  experience large losses over short periods. Market dips, sometimes
  significant, are simply part of investing in stocks.
  
  For example, consider the Dow Jones Industrials Index, a basket of 30 of the
  most popular, and some of the best, companies in America. If during the last
  100 years you had held an investment tracking the Dow, there would have been
  10 different occasions when that investment would have lost 40% or more of its
  value.
  
  The yearly returns in the stock market also fluctuate dramatically. The
  highest one-year rate of return of 67% occurred in 1933, while the lowest
  one-year rate of return of negative 53% occurred in 1931. It should be obvious
  by now that stocks are volatile, and there is a significant risk if you cannot
  ride out market losses in the short term. But don't worry; there is a bright
  side to this story.

  
  Over the Long Term, Stocks Are Best
  Despite all the short-term risks and volatility, stocks as a group have had
  the highest long-term returns of any investment type. This is an incredibly
  important fact! When the stock market has crashed, the market has always
  rebounded and gone on to new highs. Stocks have outperformed bonds on a total
  real return (after inflation) basis, on average. This holds true even after
  market peaks.
  
  If you had deplorable timing and invested $100 into the stock market during
  any of the seven major market peaks in the 20th century, that investment, over
  the next 10 years, would have been worth $125 after inflation, but it would
  have been worth only $107 had you invested in bonds, and $99 if you had
  purchased government Treasury bills. In other words, stocks have been the
  best-performing asset class over the long term, while government bonds, in
  these cases, merely kept up with inflation.
  
  This is the whole reason to go through the effort of investing in stocks.
  Again, even if you had invested in stocks at the highest peak in the market,
  your total after-inflation returns after 10 years would have been higher for
  stocks than either bonds or cash. Had you invested a little at a time, not
  just when stocks were expensive but also when they were cheap, your returns
  would have been much greater.
  
  
  Time Is on Your Side
  Just as compound interest can dramatically grow your wealth over time, the
  longer you invest in stocks, the better off you will be. With time, your
  chances of making money increase, and the volatility of your returns
decreases.
  
  
  The average annual return for the S&P 500 stock index for a single year has
  ranged from negative 39% to positive 61%, while averaging 13.2%. After holding
  stocks for five years, average annualized returns have ranged from negative 4%
  to positive 30%, while averaging 11.9%. Finally, if your holding period is 20
  years, you never lost money, with 20-year returns ranging from positive 6.4%
  to positive 15%, with the average being 9.5%.
  
  These returns easily surpass those you can get from any of the other major
  types of investments. Again, as your holding period increases, the expected
  return variation decreases, and the likelihood for a positive return
  increases. This is why it is important to have a long-term investment horizon
  when getting started in stocks.
  
  
  Why Stocks Perform the Best
  While historical results certainly offer insight into the types of returns to
  expect in the future, it is still important to ask the following questions:
  Why, exactly, have stocks been the best-performing asset class? And why should
  we expect those types of returns to continue? In other words, why should we
  expect history to repeat?
  
  Quite simply, stocks allow investors to own companies that have the ability to
  create enormous economic value. Stock investors have full exposure to this
  upside. For instance, in 1985, would you have rather lent Microsoft money at a
  6% interest rate, or would you have rather been an owner, seeing the value of
  your investment grow several-hundred fold?
  
  Because of the risk, stock investors also require the largest return compared
  with other types of investors before they will give their money to companies
  to grow their businesses. More often than not, companies are able to generate
  enough value to cover this return demanded by their owners.
  
  Meanwhile, bond investors do not reap the benefit of economic expansion to
  nearly as large a degree. When you buy a bond, the interest rate on the
  original investment will never increase. Your theoretical loan to Microsoft
  yielding 6% would have never yielded more than 6%, no matter how well the
  company did. Being an owner certainly exposes you to greater risk and
  volatility, but the sky is also the limit on the potential return.
  
  
  The Bottom Line
  While stocks make an attractive investment in the long run, stock returns are
  not guaranteed and tend to be volatile in the short term. Therefore, we do not
  recommend that you invest in stocks to achieve your short-term goals. To be
  effective, you should invest in stocks only to meet long-term objectives that
  are at least five years away. And the longer you invest, the greater your
  chances of achieving the types of returns that make investing in stocks
  worthwhile.