Why should we expect stocks to go up in the long term?
Does it make sense for stocks to earn a premium indefinitely? Yes. There is good reason to think that the stock market will make money indefinitely: the stock market is the primary mechanism through which investors bear market risk, which requires compensation.  If you think of all the owners of firms (stockholders and bondholders, generally) the risk premium that stocks earn stocks is the way bondholders pay equityholders to bear the risk that they do not wish to. Will stock prices always go up in the long run? As long as companies pay out less in dividends than their profit, prices will go up.  That could change if we were to change our corporate culture and/or tax practices so that firms paid out more in dividends.  However, for the purposes of your question, I think it doesn't matter much whether the investor makes money as dividends or capital gains. Does the 5-7% guess apply only to the US market? I didn't write (nor read) the books in question, but most likely that is a global number.  The US dominates the global equity market, so it's often a good proxy.  However, international returns taken together have no less risk and earn no less over long horizons in general.  The particular examples you have pointed out are special cases that only apply to a part of the global economy and a particular time period.  There are plenty of examples of stock markets and time periods that did much better than the US market to offset your examples. Is 5-7% a reasonable long-term estimate of equity returns? Equity will always earn more in expectation than risk-free securities will.  How much more depends on major economic factors.  5-7% has been a good estimate for the market risk premium for many, many decades (stocks should earn this plus whatever the risk-free rate is).  However, that is just an empirical observation, not a rule.  It can change.  Some day technological progress could slow down or stop, we could run out of important resources in a way that we can't compensate for, our population permanently could stop growing, aliens could invade, etc.  Down the road it is certainly possible for expected equity returns to go down and never go back up again.  This would result from a permanent, global, economic shift that I think would be pretty obvious.  That is, you wouldn't have to look at stock prices to know it was happening. I have read in many personal finance books that stocks are a great investment for the long term, because on average they go up 5-7% every year. This has been true for the last 100 years for the S&P500 index, but is there reason to believe this trend will continue indefinitely into the future? It has also been wrong for 20+ year time periods during those last 100 years. It's an average, and you can live your whole career at a loss. There are many things to support the retention of the average, over the next 100 years. I think the quip is out of scope of your actual investment philosophy. But basically there are many ways to lower your cost basis, by reinvesting dividends, selling options, or contributing to your position at any price from a portion of your income, and by inflation, and by the growth of the world economy. With a low enough cost basis then a smaller percentage gain in the index gives you a magnified profit. I feel something needs to be addressed The last 100 years have been a period of economic prosperity for the US, so it's no surprise that stocks have done so well, but is economic prosperity required for such stock growth? Two world wars. The Great Depression. The dotcom bust. The telecom bust. The cold war. Vietnam, Korea. OPEC's oil cartel. The Savings and Loans crisis. Stagflation. The Great Recession. I could go on.  While I don't fully endorse this view, I find it convincing: If the USA has managed 7% growth through all those disasters, is it really preposterous to think it may continue? The total value of the stock market more or less tracks the total value of the companies listed in the stock market, which is more or less the total value of the US economy (since very few industries are nationalized or dominated by privately held companies). The US economy has consistently grown over time, thanks to the wonders of industrialization, the discovery of new markets, new natural resources, etc.  Thus, the stock market has continued to grow as well. Will it forever?  No.  The United States will not exist for ever.  But there's no obvious reason it won't continue to grow, at least for a while, though of course if I could accurately predict that I would be far richer than I am. Why do other countries not have the same result?  China is its own ball of wax since it's a sort-of-market-sort-of-command economy.  Japan has major issues economically right now and doesn't really have the natural or people resources; it also had a huge market bubble a while back that it's never recovered from. And many European countries are doing fine.  German's DAX30 index was at around 2500 in 2004 and is now at nearly 13000.  That's pretty fast growth. If you go back further (there was a crash ending in around 2004), you can see around the fall of the Berlin wall it was still around 2000; even going that far back, that's about an 8% annual bump.  The FTSE was also around 2000 back then, around 8000 now, which is around 5% annual growth.   Many of these indexes were more seriously hurt than the US markets in the two major crashes of this millenium; while the US markets fell a lot in 2008, they didn't fall nearly as much as many smaller markets in 2002, so had less to recover from.  Both DAX and FTSE suffered similar falls in 2002 to 2008, and so even though during good periods they've grown quite quickly, they haven't overall done as well as they could have given the crashes. "Stocks ""go up 5-7% every year. This has been true for the last 100 years for the S&P500 index...."" This was true in the 20th century in America. It was not true (over the whole century) for other major countries like Germany, Russia, Japan, or China. (It was more or less true for Britain and certain Commonwealth countries like Australia and Canada.) A lot of this had to do with which countries were occupied (or not) during the two world wars. In one of his company's annual reports, Warren Buffett pointed out that the U.S. standard of living went up 6-7 times in the 20th century, that this was unprecedented (and might not be repeatable in the 21st century). The performance of the U.S. stock market in the past century is representative of those (and other) past facts. If a different set of facts prevails going forward, the U.S. stock market would be reflective of those ""different"" facts." Companies are expected to make a profit, otherwise there is no point to their existence and no motivation for investment. That profit comes back to shareholders as growth and/or dividend. If a company is doing well and has a healthy profit to turn back into investment to facilitate increased future earnings, it increases shareholder equity and share price. If a company is doing well and has a healthy profit to pay out in dividend, it makes the shares more attractive to investors which pushes the price up. Either way, shares go up. Share prices drop when companies lose money, or there are market disturbances affecting all companies (recessions), or when individual companies fail. Averaged over all companies over the long term (decades), stocks can be reasonably expected to go up. "The last 300 years of civilization have been amazingly atypical. We have experienced industrial revolution after industrial revolution.  Economic revolutions that would have changed the world in 1000 AD show up as noise.  Coal, Canal, Rail, Trade, Electricity, Refrigeration, Oil, Gas, Nuclear, Assembly Line, Vacuum Tube, Mass Education, Transistor, Integrated Circuit, Nano-tech, Antibiotics, Slaying of absolute Poverty, Democratic, Feminism, Superhighway, Automobile, Airplane, and on and on and on. A cascade of miracles and world-shaking events that have intertwined and together generated a many century long economic singularity that has upended the entire world and generated today's world. The question you should ask, is tomorrow going to be like today?  And the answer is yes; in weather, and in economics, the most likely bet bet is always ""things keep on going like they have in the short term"".  But next week?  Next month?  That is often not much like today. There is reason to believe that the yield on the above revolutions will continue to propel the economy forward, and that there are multiple promising new revolutions on the horizon. But barring that kind of world-shaking revolution, you are not going to maintain a 5% real return on investment over another centuries for the stock market.  The value of investments has to go up by a factor of over 100 in order for that to happen, and the US stock market is already close to 20 trillion dollars. For it to have a market cap of 2 quadrillion dollars the world economy will have to be much larger than it is today.  And to be that much larger, the world would have to be a much stranger place that values very different things. We are currently roughly a K-type 0.72 civilization.  A simple linear expansion of our power of 100x brings us up to K-type 0.92, which is going to cook the planet from waste heat (not from CO2, but just from the waste heat of the energy it uses!) Efficiency can mitigate this, but only to a degree.  100x more efficient technology is going to less believable than a beanstalk and space colonies. If you believe that the stock market is going to continue to grow at 5%/year for the next century, start investing in really out-there technologies.  Gene editing, virtual and augmented reality, space beanstalks and private lift, miraculously cheap energy storage, etc.  Because simply refining the technology of today won't get us there. Modern industrial civilization has been a miracle factory.  That is what pulled off that growth rate.  If the miracles stop coming, so does the growth. There is a road to it.  It would involve clean energy, mass personal automation and friendly (not smarter than human) AI, and the entire world lifted up to the standard of living of the top 3% of the USA on average.  But it is far from guaranteed." "Stock returns cannot be evaluated on its own. You need to take into account inflation and the return of other investment vehicles. Over the long run, you want to earn more than your peers (ie inflation), or lose less than them. Stock lets you buy into the profits of a company managed by others. So the fundamental question is ""do those company managers make better decision than average person?"" Of course there are times when they make awful decisions (eg just before dotcom bubble), and sometimes the best decision is to close the business. But overall those people are much better educated, have higher IQ, more resourceful, etc, and so over long time and across all the companies, this is correct and hence the stock market premium." A lot of these answers are strong, but at the end of the day this question really boils down to: Do you want to own things? Duh, yes. It means you have: By this logic, you would expect aggregate stock prices to increase indefinitely.   Whether the price you pay for that ownership claim is worth it at any given point in time is a completely different question entirely.
This is Ellie Lan, investment analyst at Betterment. To answer your question, American investors are drawn to use the S&P 500 (SPY) as a benchmark to measure the performance of Betterment portfolios, particularly because it’s familiar and it’s the index always reported in the news. However, going all in to invest in SPY is not a good investment strategy—and even using it to compare your own diversified investments is misleading. We outline some of the pitfalls of this approach in this article: Why the S&P 500 Is a Bad Benchmark. An “algo-advisor” service like Betterment is a preferable approach and provides a number of advantages over simply investing in ETFs (SPY or others like VOO or IVV) that track the S&P 500.  So, why invest with Betterment rather than in the S&P 500? Let’s first look at the issue of diversification. SPY only exposes investors to stocks in the U.S. large cap market. This may feel acceptable because of home bias, which is the tendency to invest disproportionately in domestic equities relative to foreign equities, regardless of their home country.  However, investing in one geography and one asset class is riskier than global diversification because inflation risk, exchange-rate risk, and interest-rate risk will likely affect all U.S. stocks to a similar degree in the event of a U.S. downturn. In contrast, a well-diversified portfolio invests in a balance between bonds and stocks, and the ratio of bonds to stocks is dependent upon the investment horizon as well as the individual's goals.  By constructing a portfolio from stock and bond ETFs across the world, Betterment reduces your portfolio’s sensitivity to swings. And the diversification goes beyond mere asset class and geography. For example, Betterment’s basket of bond ETFs have varying durations (e.g., short-term Treasuries have an effective duration of less than six months vs. U.S. corporate bonds, which have an effective duration of just more than 8 years) and credit quality. The level of diversification further helps you manage risk.  Dan Egan, Betterment’s Director of Behavioral Finance and Investing, examined the increase in returns by moving from a U.S.-only portfolio to a globally diversified portfolio. On a risk-adjusted basis, the Betterment portfolio has historically outperformed a simple DIY investor portfolio by as much as 1.8% per year, attributed solely to diversification.   Now, let’s assume that the investor at hand (Investor A) is a sophisticated investor who understands the importance of diversification. Additionally, let’s assume that he understands the optimal allocation for his age, risk appetite, and investment horizon. Investor A will still benefit from investing with Betterment.  Automating his portfolio management with Betterment helps to insulate Investor A from the ’behavior gap,’ or the tendency for investors to sacrifice returns due to bad timing. Studies show that individual investors lose, on average, anywhere between 1.2% to 4.3% due to the behavior gap, and this gap can be as high as 6.5% for the most active investors. Compared to the average investor, Betterment customers have a behavior gap that is 1.25% lower. How? Betterment has implemented smart design to discourage market timing and short-sighted decision making.  For example, Betterment’s Tax Impact Preview feature allows users to view the tax hit of a withdrawal or allocation change before a decision is made. Currently, Betterment is the only automated investment service to offer this capability. This function allows you to see a detailed estimate of the expected gains or losses broken down by short- and long-term, making it possible for investors to make better decisions about whether short-term gains should be deferred to the long-term. Now, for the sake of comparison, let’s assume that we have an even more sophisticated investor (Investor B), who understands the pitfalls of the behavior gap and is somehow able to avoid it. Betterment is still a better tool for Investor B because it offers a suite of tax-efficient features, including tax loss harvesting, smarter cost-basis accounting, municipal bonds, smart dividend reinvesting, and more. Each of these strategies can be automatically deployed inside the portfolio—Investor B need not do a thing. Each of these strategies can boost returns by lowering tax exposure. To return to your initial question—why not simply invest in the S&P 500? Investing is a long-term proposition, particularly when saving for retirement or other goals with a time horizon of several decades. To be a successful long-term investor means employing the core principles of diversification, tax management, and behavior management. While the S&P might look like a ‘hot’ investment one year, there are always reversals of fortune. The goal with long-term passive investing—the kind of investing that Betterment offers—is to help you reach your investing goals as efficiently as possible.   Lastly, Betterment offers best-in-industry advice about where to save and how much to save for no fee. In my opinion, the average investor should not be buying individual stocks. One reason why is that the average investor is not capable of reading financial statements and evaluating whether a stock is overpriced or underpriced. As such, they're often tempted to make buy/sell decisions based solely on the current value of a stock as compared to the price at which they bought it. The real reasons to buy (or sell) a stock is the expectation of future growth of the company (or continued profit and expected dividends). If you aren't able to analyze a company's financial statements and business plan, then you really aren't in a position to evaluate that company's stock price. So instead of asking whether to sell based on a recent drop in stock price, you should be investigating why the stock price is falling, and deciding whether those reasons indicate a trend that you expect to continue.  If you buy and sell stocks based solely on recent trends in the stock price, you probably will end up buying stocks that have recently risen and selling stocks that have recently fallen. In that case, you are buying high and selling low, which is a recipe for poor financial outcomes. This is a great question for understanding how futures work, first let's start with your assumptions The most interesting thing here is that neither of these things really matters for the price of the futures.  This may seem odd as a futures contract sounds like you are betting on the future price of the index, but remember that the current price already includes the expectations of future earnings as well! There is actually a fairly simple formula for the price of a futures contract (note the link is for forward contracts which are very similar but slightly more simple to understand).  Note, that if you are given the current price of the underlying the futures price depends essentially only on the interest rate and the dividends paid during the length of the futures contract.  In this case the dividend rate for the S&P500 is higher than the prevailing interest rate so the futures price is lower than the current price.  It is slightly more complicated than this as you can see from the formula, but that is essentially how it works. Note, this is why people use futures contracts to mimic other exposures.  As the price of the future moves (pretty much) in lockstep with the underlying and sometimes using futures to hedge exposures can be cheaper than buying etfs or using swaps. Edit: Example of the effect of dividends on futures prices For simplicity, let's imagine we are looking at a futures position on a stock that has only one dividend (D) in the near term and that this dividend happens to be scheduled for the day before the futures' delivery date.  To make it even more simple lets say the price of the stock is fairly constant around a price P and interest rates are near zero.  After the dividend, we would expect the price of the stock to be P' ~ P - D as if you buy the stock after the dividend you wouldn't get that dividend but you still expect to get the rest of the value from additional future cash flows of the company. However, if we buy the futures contract we will eventually own the stock but only after the dividend happens.  Since we don't get that dividend cash that the owners of the stock will get we certainly wouldn't want to pay as much as we would pay for the stock (P).  We should instead pay about P' the (expected) value of owning the stock after that date.   So, in the end, we expect the stock price in the future (P') to be the futures' price  today (P') and that should make us feel a lot more comfortable about what we our buying.  Neither owning the stock or future is really necessarily favorable in the end you are just buying slightly different future expected cash flows and should expect to pay slightly different prices. I haven't seen any of the other answers address this point – shares are (a form of) ownership of a company and thus they are an entitlement to the proceeds of the company, including proceeds from liquidation. Imagine an (extreme, contrived) example whereby you own shares in a company that is explicitly intended to only exist for a finite and definite period, say to serve as the producers of a one-time event. Consider a possible sequence of major events in this company's life: So why would the shares of this hypothetical company be worth anything? Because the company itself is worth something, or rather the stuff that the company owns is worth something, even (or in my example, especially) in the event of its dissolution or liquidation. Besides just the stuff that a company owns, why else would owning a portion of a company be a good idea, i.e. why would I pay for such a privilege? Buying shares of a company is a good idea if you believe (and are correct) that a company will make larger profits or capture more value (e.g. buy and control more valuable stuff) than other people believe. If your beliefs don't significantly differ from others then (ideally) the price of the companies stock should reflect all of the future value that everyone expects it to have, tho that value is discounted based on time preference, i.e. how much more valuable a given amount of money or a given thing of value is today versus some time in the future. Some notes on time preference: But apart from whether you should buy shares in a specific company, owning shares can still be valuable. Not only are shares a claim on a company's current assets (in the event of liquidation) but they are also claims on all future assets of the company. So if a company is growing then the value of shares now should reflect the (discounted) future value of the company, not just the value of its assets today. If shares in a company pays dividends then the company gives you money for owning shares. You already understand why that's worth something. It's basically equivalent to an annuity, tho dividends are much more likely to stop or change whereas the whole point of an annuity is that it's a (sometimes) fixed amount paid at fixed intervals, i.e. reliable and dependable. As CQM points out in their answer, part of the value of stock shares, to those that own them, and especially to those considering buying them, is the expectation or belief that they can sell those shares for a greater price than what they paid for them – irrespective of the 'true value' of the stock shares. But even in a world where everyone (magically) had the same knowledge always, a significant component of a stock's value is independent of its value as a source of trading profit. As Jesse Barnum points out in their answer, part of the value of stocks that don't pay dividends relative to stocks that do is due to the (potential) differences in tax liabilities incurred between dividends and long-term capital gains. This however, is not the primary source of value of a stock share. "There are two things going on here, neither of which favors this approach. First, as @JohnFx noted, you should be wary of the sunk-cost fallacy, or throwing good money after bad. You already lost the money you lost, and there's no point in trying to ""win it back"" as opposed to just investing the money you still have as wisely as possible, forgetting your former fortune. Furthermore, the specific strategy you suggest is not a good one. The problem is that you're assuming that, whenever the stock hits $2, it will eventually rebound to $3. While that may often happen, it's far from guaranteed. More specifically, assuming the efficient market hypothesis applies (which it almost certainly does), there are theorems that say you can't increase your expected earning with a strategy like the one you propose: the apparent stability of the steady stream of income is offset by the chance that you lose out if the stock does something you didn't anticipate." No. The long-term valuation of currencies has to do with Purchasing Power Parity.  The long-term valuation of stocks has to do with revenues, expenses, market sizes, growth rates, and interest rates. In the short term, currency and stock prices change for many reasons, including interest rate changes, demand for goods and services, asset price changes, political fears, and momentum investing.  In any given time window, a currency or stock might be: The Relative Strength Index tries to say whether a currency or stock has recently been rising or falling; it does not inherently say anything about whether the current value is high or low. Stock index funds are likely, but not certainly, to be a good long-term investment.  In countries other than the USA, there have been 30+ year periods where stocks either underperformed compared to bonds, or even lost value in absolute terms.  This suggests that it may be an overgeneralization to assume that they always do well in the long term.  Furthermore, it may suggest that they are persistently overvalued for the risk, and perhaps due for a long-term correction.  (If everybody assumes they're safe, the equity risk premium is likely to be eaten up.) Putting all of your money into them would, for most people, be taking an unnecessary risk.  You should cover some other asset classes too.  If stocks do very well, a portfolio with some allocation to more stable assets will still do fairly well.  If they crash, a portfolio with less risky assets will have a better chance of being at least adequate. What the automation mostly does is make short-term trading that much more difficult. Day trading is a zero-sum game, so if they win more, everyone else wins less.  Long term trading (years to decades) is a positive-sum game; the market as a whole tends to move upward for fairly obvious reasons (at its basis it's still investing, which in turn is based on lending, and as long as folks make fairly rational decisions about how much return they demand for their investment and the companies are mostly producing profits there will be a share of the profit coming back to the investors as dividends or increased share value or both. Day-to-day churn in individual stocks gets averaged out by diversification and time, and by the assumption that if you've waited that long you can wait a bit longer if necessary for jitters to settle out. Time periods between those will partake of some mix of the two.