Investors should be aware of all investment risks when investing, but they are not. The only risk that seems to get the attention of 99% of investors is risking capital. Investors typically worry about volatility by equating high volatility with high risk. What they fail to realize is that the most volatile assets lead to the highest returns over time.
Obviously, stocks are considered more volatile than bonds. However, the risks associated with investing in the stock market dissipate over time. There have been three instances since World War II where stocks lost 48% or more in bear markets. In each case, the stock market fully recovered these losses on its way to continuing and achieving new highs.
It is necessary to adopt a long-term time horizon when investing in the stock market to reduce capital risk. The S&P 500’s 10-year rolling returns through 2024 show an average cumulative return of 221% since 1971. Over 20-year periods, the average cumulative return jumps to 880%. Cumulative returns in both periods far exceeded the corresponding rise in inflation as measured by the Consumer Price Index, leading to significant gains in purchasing power.
The second risk relates to opportunity costs. Looking at the HFRI hedge fund data tells a whole story. Over a 10-year period ending in 2024, a typical long-biased equity hedge fund earned a cumulative return of 84% versus 245% for the S&P 500. Thus, the opportunity costs of not investing fully in stocks were nearly twice the money earned by long-biased equity hedge funds.
The third risk relates to the loss of purchasing power, which is something investors rarely take into account. Some key advisory advice has called for maintaining significant exposure to bonds throughout retirement. Specifically, these advisors apply the “rule of 100” derived by subtracting an individual’s age from 100 to arrive at the individual’s exposure to stocks. In the case of a 65-year-old, the portfolio mix would be 65% in bonds and 35% in stocks according to this methodology. In some cases, unjustifiably conservative investors keep a portfolio invested 100% in bonds.
How has investing 100% in long government bonds performed over the past 10 years? New York University Stern School of Business research shows that investing in 10-year government bonds yielded a 2.7% return on a cumulative basis for the 10-year term ending in 2024.
Meanwhile, the Consumer Price Index rose 32% over the same period, significantly reducing the purchasing power of this bond portfolio. In short, investors need to consider the potential loss of opportunity costs and potential loss in purchasing power as well as capital risk when formulating their investment strategy. History shows that ignoring opportunity risks and purchasing power can turn into financial penalties in the future.
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Robert Zuccaro, CFA is the founder and chief investment officer of Golden Eagle Strategies. Robert has more than four decades of experience in equity research and fund management, having led institutional portfolios through multiple market cycles. He has been recognized by national financial publications for his work in systematic investing.
Email:info@goldeneaglestrategies.com / Phone: (561) 510-6606
