The Lessons of Market History for Novice Investors
~Use knowledge of the past to set your expectations and control your emotions~
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Past performance is no guarantee of future results. Every mutual fund you own says something to that effect in its literature. And yet, ignoring the past--in investing or in any other field--is rarely a wise move. I don't mean you should be a performance-chasing hound. Buying funds that sport the gaudiest one- and three-year returns, for example, can easily lead you astray. However, knowing something about stock market history can help you set expectations for your investments. That can be extremely useful for novice investors who have little experience navigating the turbulence of the markets.
The Lessons of History Armed with our knowledge of history, we can, however, reach a few helpful conclusions.
1. For long-term money, stocks likely remain the best investment. They may not return what they have in the past, but another asset class that can keep pace with inflation as well as stocks has not presented itself. Because of their volatility, however, stocks remain bad investments for short-term money (cash that you'll use for a down payment on a house in six months, for example). In fact, Siegel says that stocks are inappropriate investments for money that you're planning to spend within five years.
2. Knowing history can help you manage your emotions, which may be the most important part of investing. Just when you want to throw in the towel after a period of stock market decline, those stocks may bounce back. Also, just when you're likely to feel most confident in them is when they're prone to disappoint. Keeping a long-term perspective and trying to focus more on your time frame than on the daily and yearly fluctuations can make you a better investor.
3. Broad-based mutual funds, including index funds that track the S&P 500 or Wilshire 5000 indexes, give individual investors a good chance to capture much of the market's return over time. Stick to these kinds of investments with the bulk of your assets, and try not to pay attention to various sectors that may be running hard for short periods of time. It's easy to feel like a dolt at a cocktail party when you don't own the latest high-flying sector, but armed with history you'll realize that periods of unusually strong performance can't continue for the market as a whole or for an individual sector.
4. Fees matter. Because beating inflation, especially for bonds, is difficult, paying a large expense ratio on your mutual funds is effectively asking you to fight with one hand tied behind your back. Look for low-fee mutual funds.