Most entrepreneurs dislike and distrust the stock market because of the lack of control involved in equities investing. After all, entrepreneurship is a hands-on activity in which one person has control of enterprise, while a stock is simply a piece of somebody else’s business.
Distrusting the stock market can be a terrible mistake because equities are still one of the best methods of protecting and preserving wealth available. The reason for this is simple: The average return on stocks exceeded almost every investment out there.
A good way to see the power of stocks is to take a look at the Compound Annual Growth Rate, or CAGR, of an index of stocks. The CAGR is important because it is the standard formula used to calculate stock returns; in this case, the main American stock index, the S&P, or Standard & Poor’s, 500, a list of the 500 largest publicly traded companies in the United States.
The calculator provided by moneychimp.com estimated that the average return on the S&P 500 between January 1, 1980, and December 2014 was 8.35%. According that calculator, $1,000 (€.91) invested in S&P stocks would have grown to $16,560 (€1,506.05) when adjusted for inflation.
This growth occurred in a volatile period of economic history that saw three major bull markets in U.S. stocks (the 1987 crash, the dot.com bust of 2000 and the great meltdown of 2008). History and the CAGR show us that stocks seem to be the most resilient investment in the modern markets.
Nor was it just American stocks that offered such a rate of return. The main German stock index, the Deutsche Borse AG, or DAX, offered investors a one year rate of 18.03% and a year to date return of 17.4% on July 23, 2015, according to information provided by Bloomberg.
Stocks Retain Value
The high return on stocks seems to come from the fact that these instruments regain lost value far faster than other investments. A prime example of this is residential real estate.
The average home price in the United States in May 2015 was $228,700 (€207,017.40), which on paper was close to the price seen at the peak of the last U.S. real estate bubble in 2006: $230,400, or €208,555.86. It took U.S. real estate nine years to recover from the collapse of the last real estate bubble.
Actually, it has not yet recovered when inflation is factored in: The 2006 average home price, $230,400, equals $271,777.14 (€246,010.05) in 2015 currency, according to the CPI Inflation Calculator provided by the United States Bureau of Labor Statistics. The average home price would have to rise to around $272,000 (€246,211.78) for an American that purchased a home in 2006 to cover the initial investment cost.
Yet the stock market did recover fairly quickly; a person that invested $230,000 (€209,767.89) in the S&P 500 in 2006 would have seen that money grow to $256,707.22 ($234,125.79) by 2010, according to Bankrate.com’s Historical Returns Investing Calculator. The person who “invested” in the house would still be underwater when inflation is factored in.
An even worse investment for retaining value is precious metals such as gold. Gold hit its highest historical price on the London Market in January of 1980: $2,079.33 (€1,896.42) when adjusted for inflation, according Macrotrends.com. On July 24, 2015, gold was trading at $1,083 (€987.73) a troy ounce, according to Goldprice.com. In fact, the metal has never returned to the 1980 price; the closest it came was $1,921.73 (€1,752.68) an ounce in August of 2011.
A person that bought gold at the highest price in 1980 would still be waiting to recover his or her initial investment. In contrast, a person that invested $2,079.33 (€1,896.42) in the S&P 500 in 1980 would have made $83,379.74 (€76,045.18) by 2013, according to the Historical Returns Investing Calculator.
The ability to generate a high return and retain value is what creates the greatest and most underrated benefit of stocks: liquidity. Stocks, unlike real estate but like commodities, can be traded fairly quickly. That means the investment can be converted to cash or borrowed against fairly quickly, which is often of vital importance to entrepreneurs.
The high level of liquidity of some stocks, particularly American growth stocks like Google (NASDAQ: GOOG), has made them an ideal place for some entrepreneurs to park extra funds. An added benefit to stocks is that they are less susceptible to inflation and the rate of exchange than cash or currency futures are.
Entrepreneurs need to invest in stocks because no other investment can offer a similar level of return and liquidity. Those who are skeptical of the stock market need to understand that there may be no alternative to it in today’s world.