How to Virtually Eliminate the Risk of Capital Loss

Feb 26, 2021
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SMI emphasizes the importance of having a long-term view when it comes to executing your investment strategy. We typically define that as having, at a minimum, a 10-year time frame in mind. Why 10 years? Because that’s long enough for the annual ups and downs in the market to settle out and allow the upward bias of the market (due to the strength of the U.S. economy) to assert itself.

(A five-year period is the minimum we would recommend for investing in the stock market at all. A 10-year period — or longer — is required, in our view, to consider oneself a long-term investor.)

To illustrate this for you, we’ve researched the results of a monthly dollar-cost-averaging (DCA) program over each of the 10-year periods starting with 1950-1959 and moving through the decades up through the end of last year. We’ll share those in a moment, but first a DCA primer for new readers.

Dollar-cost-averaging is a systematic “formula” strategy that can be quite useful because it requires that you make your buying and selling decisions based solely on mechanical guidelines. Here’s all you do: (1) invest the same amount of money (2) at regular time intervals. The amount and frequency are up to you. You could invest $1,000 every three months. Or $100 every month. The important thing is to pick an amount you can stick with faithfully over the years.

Your constant dollar amounts “force” you to buy more shares when the price is low and fewer shares when the price is high. In effect, you are buying more at bargain prices and fewer at what might be considered high prices. Of course, only when you look back years from now will you know when prices really were bargains and when prices were too high.

A disciplined approach

The beauty of DCA is that it frees you from the worry of whether you’re buying at the “wrong” time. It is critically important to ignore all market fluctuations when employing a dollar-cost-averaging strategy! Most investors who obtain poor returns in the market are victims of their own emotions. Only after prices have been rising sharply do they work up enough courage to buy fund shares. And about the only time they ever sell shares is when they become especially fearful after prices have plunged. The result is that they buy high and sell low, the very opposite of their ambition. You must exercise the discipline of maintaining your systematic investment program.

You can make your DCA investments as frequently as you wish: weekly, monthly, or even quarterly. However, for best results, it is better to make more frequent investments. The reason for this is that market lows may not occur near the time you are scheduled to make an investment. The more frequently you invest, the greater likelihood your program will enable you to buy shares near intermediate-term lows. As you can see, this strategy almost makes you hope that the market will fall so you can accumulate more shares for your money!

Decades of data

Now, to the research. The goal was to get an idea of the level of risk an investor is taking in a DCA strategy lasting 10 years. Going all the way back to 1950, we assumed an investor deposited $100/month into an S&P 500 index fund at the beginning of each month. Our disciplined investor did this for an entire decade — through good economic times and bad, bull and bear markets, wars, and other geopolitical crises.

Instead of simply measuring the most recent “calendar decades” (the ‘50s, ‘60s, ‘70s, etc.), we examined a total of 62 “decades” by assuming the starting date for our investor could have been January 1 of any year. So, for example, we measured from Jan. 1, 1958 to Dec. 31, 1967, and Jan. 1, 1984 to Dec. 31, 1993. And, of course, Jan. 1, 2011-Dec. 31, 2020.

Here’s what we found. Of the 62 decade-long periods we tested, the average result was that the investor’s account was worth $21,841 at the end of 10 years. Of this, $12,000 was the investor’s own money ($100/month times 120 months). Thus, the average actual profit was $9,841. That represents an 11.5% annualized rate of return. Because this is an average, some 10-year periods were better and some were worse. Only in two, however, was there a loss:

  • At the end of the 1965-1974 period, which closed with the worst bear market since the Depression (until 2000-2002 and 2008 came along), the account was worth $10,611. This was $1,389 less than had been deposited over the 10 years.

  • At the end of the 1999-2008 period, which included, not one, but two fierce bear markets, the account was worth $9,958. This was $2,041 below the $12,000 invested during the decade.

In both of these cases, however, the years following (1975 and 2009) were boom years that launched new bull markets. Investors who stayed for year 11 were rewarded with returns of 25% and more.

Steady as she goes

The significant takeaway from this study is simply this: Over the past 70-plus years, it has been very rare to lose money over a 10-year period when investing in a diversified portfolio such as the S&P 500. This was the case despite the many recurring difficulties we have endured since World War II. As Ron Blue points out in his 1994 book Storm Shelter:

In 1952, in the shadow of the spread of Communism, amid the mud and blood of the Korean War, bomb shelters were among the best-selling items in the United States.

In 1962, the specter of economic and political uncertainty had hovered in every corner of the world. Our amazement at seeing a shoe-pounding Nikita Khrushchev vow to “bury” us turned to horror as the Cuban missile crisis unfolded. At that point a nuclear holocaust seemed at least possible, if not imminent. And Vietnam lay around the corner.

In 1972, we had been saddled with Watergate and an oil crisis that threatened to throttle the world’s economy. Who can forget the lines at the gas stations or the rationing of fuel oil that winter? Then, too, I remember being hit with wage and price controls for the first time since World War II. And for the first time in my memory, the prime rate hit ten percent. Economic security seemed an elusive, if not impossible, dream.

In 1982, interest and inflation rates had soared to all-time highs, investors faced crushing tax brackets, and the price of gold leapfrogged daily. Taking stock of the situation, most analysts warned of a devastating financial explosion within the next few years. And on and on and on. The point is that we will always face uncertainty.

Respond to uncertainty with consistency

If Ron had written his book recently, he could have added the fears surrounding the bursting bubble of the dot-com craze in 2000, the historically sluggish recovery in 2010 that was accompanied by massive amounts of new government debt, and of course the COVID-19 pandemic that temporarily cut stock market values by a third last year. All of these events gave investors pause.

Yet despite the fact that we must always live with economic uncertainty, a strategy of diversification combined with a long-term perspective has a history of getting investors through the tough times. A consistent, disciplined DCA strategy is a great approach for the average investor who is willing to adopt the long view. And while there will be ups and downs along the way, there is little risk to one’s capital for those who will stay the course for a decade or more.

Written by

Austin Pryor

Austin Pryor

Austin Pryor has 40 years of experience advising investors and is the founder of the Sound Mind Investing newsletter and website. He's the author of The Sound Mind Investing Handbook which enjoys the endorsements of respected Christian teachers with more than 100,000 copies sold. Austin lives in Louisville, Kentucky, with his wife Susie. They have three grown sons and many grandchildren.

Mark Biller

Mark Biller

Mark Biller is Sound Mind Investing's Executive Editor. His writings on a broad range of financial topics have been featured in a variety of national print and electronic media, and he has appeared as a financial commentator for various national and local radio programs. Mark also serves as Senior Portfolio Manager to SMI Advisory Service’s Private Client managed-account program and the SMI Funds.

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