Consider just a few of the scary events that have shaken even the most experienced investor's confidence in the future of the national and global economies:
- 1950s: Korean War, creation of the Warsaw Pact, Cuban Revolution
- 1960s: Cuban missile crisis, Vietnam War escalation, American spy plane shot down over Soviet Union
- 1970s: Arab oil embargo, Stagflation, Watergate
- 1980s: Savings and Loan crisis, Latin American debt crisis, failed military attempt to end the Iranian Hostage Crisis
- 1990s: Asian financial crisis, Persian Gulf War
- 2000s: September 11 attacks, subprime lending/housing meltdown, Great Recession
- 2010s: Nuclear threats from North Korea, Greek bailout and eurozone crisis, mortgage delinquencies peak above 14 percent
Still, throughout it all, investors who kept on keeping on throughout the decades wound up making money over time, even with the rough patches that hit every single decade.
The 20-Year Time Horizon
If you want investing to really work out for you, you need at least somewhere in the neighborhood of 20 years to let it work its magic on your behalf.
Why 20 years? There are basically two reasons that's the magic number.
- First, the longer you have to invest, the less you need to put away each paycheck to eventually reach your goal.
- Second, while the market has generally moved up over time as companies and the economy grow, not every year is smooth sailing for investors.
Time Really Is Money
The chart below shows you how much you'd need to sock away every month to reach a $1 million nest egg, based on various potential rates of return and years investing in the plan:
Data from author's calculations. Assumes monthly contributions and compounding.
With enough time and discipline to sock away cash for an entire 40-year career, retiring a millionaire is a fairly straightforward proposition, especially if you're investing in a tax-efficient manner (by putting the money in your IRA and 401(k) or other company sponsored plan) and achieving 8 percent to 10 percent annual returns. That 8 percent to 10 percent annual rate may seem high, but in reality, it's about in line with what the S&P 500 (^GSPC) has achieved on average over time, with dividends reinvested.
Indeed, once you have fewer than 20 years left, the amounts you need to save to reach your goal start getting painfully high, especially for those who have never invested before and have gotten used to living on their full salaries.
And if you think it's tough to come up with around $1,500 per month to invest for 20 years, imagine how much tougher it'd be to come up with the nearly $5,000 per month it'd take for you to get there in only 10 years.
Time Heals Many Wounds
The other reason that 20-year time period matters so much is because of Benjamin Graham's famous quote on how the market behaves.
Graham, the man who taught value investing to Warren Buffett, noted that over the short term, the market acted like a "voting machine," but over the long term, it acted like a "weighing machine."
In other words, on any given day, the market acts something like a popularity contest, voting up and down stocks based largely on its mood. But the longer your time frame, the more closely the overall returns on stocks match the true performance of the businesses they represent. A time frame of 20 years is enough to let the market's "weighing machine" take over.
Because of that, you're more likely to get a solid return, in line with true company growth rates, over a longer period of time than you will in any given month or year.
As the chart below shows, looking back to 20-year periods starting in 1950, the market's annualized returns have generally been positive and within a fairly narrow range between around 2.4 percent and 14.4 percent. And don't forget, during each of these time periods investors faced some pretty earth-shaking events, such as those listed above.
Data from Yahoo! Finance. Comparing month end to month end, 20 years apart.
For contrast, if you look just at one-year periods rather than 20-year periods, the returns range from negative 44.8 percent to positive 52.9 percent over the same time frame, which is some incredible volatility.
While there are no absolute guarantees in investing, the odds are a lot more in your favor that you'll hit somewhere near a reasonable rate of return the longer your time frame. With 20 years or more to let the market work its magic for you, you have a pretty awesome chance at winding up successful.
Chuck Saletta is a Motley Fool contributing writer. For more on long-term investing see The Motley Fool's free report "3 Stocks That Will Help You Retire Rich." The best investing approach is to choose great companies and stick with them for the long term. This free report names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of.