One of the most fundamental pieces of financial advice is to start investing as early as possible and hold your investments as long as possible. This sensible piece of investing wisdom is derived from the observation that, over time, the American stock market keeps going up. The question investors have, though, is why it keeps rising. Here’s what you need to know about why the market goes up over time and the forces that continue propelling it to new heights.
Stocks have been around since the Dutch East India Company began issuing ownership shares in the early 1600s. In America, the concept of stock trading took off in 1790, when the Philadelphia Stock Exchange was formed. Throughout the 19th century, stock issues became an increasingly important component of business finance. By the early 1900s, stock indices began tracking the performance of specific groups of stocks, laying the groundwork for something similar to the market as it exists today.
As you can see, the history of stock markets roughly parallels the history of modern commerce, from early merchant trading fleets to modern, global corporations. As a result, their historic growth is heavily tied to the economic, demographic and technological changes that have occurred over the same period.
One of the main reasons the stock market has historically risen is technological advancement. Beginning in the 19th century, companies took advantage of industrialization and economies of scale to increase their productivity. Later, computers, the internet and other digital technologies once again revolutionized the business world. Technological improvement allows companies to be more productive, gradually increasing their cash flows each year. New technologies also open the door to new products and services, allowing existing companies to expand their offerings and creating room for new businesses to add to the value of the overall market.
Population growth also contributes to the growth of the stock market. As populations grow, workers become more specialized. This leads to greater productivity as those workers fill niche roles and perform narrower sets of tasks in an increasingly optimized manner. Economies with larger populations can support more industries, leading to market growth. Population growth also increases the number of consumers for companies to sell goods and services to, creating more opportunities for these companies to grow.
The year-on-year increases in company values because of higher productivity, technological advancement, and rising population lead to a phenomenon known as compound growth. Compound growth describes the growth of a stock, an index or an overall economy over time, considering its gains in previous years. For instance, consider a stock whose value increases by 10 percent annually. If you invest $100 today, the stock would be worth $110 next year and $121 the year after that. By the five year mark, your investment would be worth about $161. This compounding growth effect, while caused by the other factors discussed so far, is what actually keeps the market going up.
As you can see, compound growth strongly favors a long-term investing strategy in which investors buy stocks or indices and allow them to grow over long periods of time. For example, if you had invested $10,000 into a low-cost S&P 500 index fund in 1980, that investment would have grown to over $750,000 by the year 2018. That such relatively small investments can grow exponentially over time is why investing early is one of the best ways to achieve financial independence by the time you retire.
The buy-and-hold investment strategy has also fueled some of the largest and most prominent investments in individual stocks. Warren Buffett’s famous bet on Coca Cola is a prime example. Between Buffett’s initial purchase of shares in the company in 1988 and 2019, Coke had appreciated by an astonishing total of 1,750 percent. In other words, a retail investor who had put just $5,000 into the company in 1988 would have had shares valued at about $87,500 in 2019.
The long-term buy and hold strategy has also proven to be extremely robust for mitigating the risk of losses. In fact, the overall American stock market has never lost money over a period of 20 years or more. Even though it reliably goes up over time, the American stock market regularly has individual years of losses. By investing over the long-term, it’s much easier to ensure a positive return and take advantage of compounding growth.
How Can You Do This?
As you can see, investing early and holding for the long-term is a proven way to take advantage of the forces behind economic growth. If you’re looking for a simple way to put your money to work, . This easy-to-use investment service allows you to invest in a diversified investment plan based on your personal risk tolerance, goals and financial plan.
