Cynicism, perpetuated by the financial media, has unfortunately become a somewhat fashionable worldview. When objectively analyzed, however, cynicism not only robs you of what is arguably an indispensable ingredient for happiness in life – hope for the future – but also of wealth. By understanding the wealth-creating mechanics of free market capitalism and the construction of stock market indexes, however, one can see the “bigger picture” when confronted with hard times. This leads one to adopt an alternate worldview, one of rational optimism, which, unlike the destructive cousins cynicism and naivete, challenge one to think of hard times not only as something that will pass, but as a necessary process for creating the good times that are almost inevitably right around the corner.
When perusing the news headlines that we are bombarded with daily, it can become all-too-easy to succumb to the toxic force of cynicism. In fact, there are people and even entire organizations who have built their careers or businesses on spewing cynicism. And by doing so, they have managed to infect even the most otherwise rational and happy individuals with their life-sucking disease, robbing them of the joy that comes with having hope for the future. Cynicism does much more than rob us of our rationality, however. When people make decisions or take actions based on this type of distorted reasoning, they will also, almost certainly, be robbed of wealth.
Your Enemy, The Media
It is without question that the locust of a cynical worldview is the media, mainstream or otherwise. Not a day goes by that we aren’t reminded of “how bad things are” in the world, and “how it’s only going to get worse”.
Before believing or taking action based on anything that you read on the news or hear on the television, it is important to remember why their message is what it is. The media’s objective is to make money. And media outlets do not make money by building your wealth, saving you taxes, protecting your legacy, or by providing you with anything that anyone would mistake for sound financial advice. They make money by advertising. The primary way this is done is through clicks (if online), or viewers (if televised). And nothing generates clicks or viewers like fear. All they need you to do is click on their fear-mongering headline. Then they collect their ad revenue and they’re done with you. Oftentimes, in fact, all that’s behind those headlines is only a few paragraphs written by an “analyst” who has no idea what they’re talking about.
In preparation for this post, I decided to take a random look at a few popular and commonly visited financial “news” sites to see what some of their headlines for the day were. As expected, it was all-too-easy to find a common thread amongst all of them: a message rooted in fear.
MarketWatch: “U.S. leading economic indicators signaling midyear recession: Conference Board”
Forbes: “Why 186 Other Banks Could Go The Way Of Silicon Valley Bank”
CNBC: “2-year Treasury yield tumbles as economic data points to contracting economy”
Bloomberg: “BlackRock Delivers Stark Warning on US Debt Default”
Now, there might very well be truth behind these headlines. Perhaps the economy actually is about to enter a recession, or perhaps one hundred other banks are about to share the same fate as Silicon Valley Bank. What doesn’t get communicated, however, is that these events have precisely nothing to do with you or your financial plan and should therefore have no bearing on your investment strategy. Furthermore, you will never see the media report on any of the mechanisms that make stocks such an unbelievable deal for the long-term (discussed below). For example, how many of you reading this knew that the dollar-dividend of the S&P 500 went up last year, despite the index losing about 20% of its value? Good news, unfortunately, does not sell nearly as well as bad news (real or imagined), and the best course of action when it comes to digesting the “news” delivered by the financial media is the following: perpetual ignorance.
Why stocks will basically always go up (in the long term)
Now that my media diatribe is over, we can discuss the primary point of this post: why stocks are basically always a good deal (in the long term), regardless of the insistence of media pundits who insist that the country will soon be finished. The key here is to understand the seemingly miraculous wealth creating mechanisms of free-market capitalism.
In a free market, companies will make a profit if, and only if, assuming no illegal practices on behalf of the firm, they are providing goods and services that consumers want. They do this by taking the resources at their disposal (namely: land, labor, and capital) and combining them in a fashion that produces goods consumers are willing to pay more for than it costs the firm to produce. That is, they make a profit. Profit, in a free market, is the firm’s signal that it is building wealth and providing solutions to consumers’ problems. The better they do this, the larger their profit. To the extent that a firm fails at this, it will incur a loss and will soon be driven out of business. And the resources that this firm used to produce goods that consumers ultimately didn’t want or weren’t producing in a fashion that rivaled that of their competitors now become free to pursue other, more profitable endeavors. The beauty of this process is that it happens almost automatically. It is undirected and dynamic, assuming the proper legal and cultural backdrop.
Let’s think about what this process means from the lens of the stock market. Take the S&P 500, for example. The S&P 500 is an index that contains the 500 largest publicly traded companies in America. And firms usually don’t become one of the 500 largest in the country without also being highly successful and profitable. Therefore, we can accurately say that the S&P 500 index is composed of the 500 largest and most successful companies in America.
When a company no longer qualifies as one of the 500 largest and most successful, it is dropped from the index and replaced with one that does. This will occur under one of two circumstances. The first is when a smaller company starts to grow at an extremely fast pace and becomes valuable enough to enter the index. Tesla (TSLA) comes to mind as a recent and widely recognized example. The second is simply the opposite: when a company becomes unprofitable and loses enough value to no longer be considered one of the 500 largest and most successful companies in America. Silicon Valley Bank (SVB) is an example that should still be fresh on everyone’s mind. In the first case, a highly innovative and rapidly growing company is taking the place of a company that, for whatever reason, isn’t growing fast enough to outpace the up-and-comer. In the second case, a company with poor prospects will find itself replaced by a company with a presumably brighter future. In other words, due to the very structure of the index, it is always improving itself by replacing companies who aren’t producing wealth with those that are. Given this description of the index’s operation (or any similar stock index, for that matter) is it any wonder that it has managed to produce, with dividends reinvested, a 10% annualized rate of return for over 100 years? That is, given that constant general improvement of its constituent companies is built into its DNA, why would we ever be surprised to discover that it is more valuable at the end of long stretches of time?
Of course, this process can be interrupted in the short term via government intervention, namely war or irresponsible monetary policy (these are usually very closely intertwined). But in the long run (time spans covering twenty years and longer), it will surely provide a patient investor (retirees included!) with the opportunity to participate in life changing wealth compounding and preservation.
Optimism for the future
Understanding the mechanisms described above is the true antidote to the mind-disease that is cynicism. Don’t mistake this, however, for naivete – cynicism’s equally destructive cousin. This is, rather, a rational optimism. It is hope for the future, but not one that is rooted in some flowery belief that man is inherently good and that everything will just magically “work out”. No, not at all. Rational optimism is simply the recognition that humanity and free market capitalism are unbelievably adaptive and will therefore trend towards general improvement. It is not the belief that hard times don’t happen, but that we persist in spite of them and emerge stronger because of them. Maybe the next recession rolls around and is far worse than anyone thinks. Maybe the dollar actually does lose its global reserve status (I don’t see this as a near term possibility). Or perhaps the US even defaults on its debt (which has happened twice in our history). The point is that life goes on. And over the remainder of your life, whatever dark days might come around won’t hold a candle to the good times that await around the corner.