Risk is everywhere.

There’s the short term uncertainty of not knowing what news will drive the market up or down. Then there’s the medium term uncertainty of not knowing which companies will still be around in 10 years, or whether a country might hit a period of stagnation.

But there are long-term risks too. A couple in particular that I’ve been asked about, often by newer investors who are thinking further into the future.

This article is loaded with great questions, and I’ll cover them as best I can. Admittedly, I don’t have all the answers, and I certainly don’t have a crystal ball. So what follows is simply how I think about these two risks with my own investing.

So what are they? Let’s get into it.

Risk 1: What if everyone invests in shares? Won’t the prices become unsustainable?

When people start investing in shares and begin to imagine a brighter future for themselves, their immediate thought is often: “wow, everyone should do this.” But then they wonder if that would be problematic. Because if everyone invests in shares, then surely the market would get overinflated and become a bubble that’ll eventually pop, right?

Combine that with strong population growth, which sees the amount of money going into superannuation (and therefore, shares), and surely that will push prices even higher. Finally, certain vocal commentators have been claiming for years that index funds themselves are going to cause a crash given their popularity. Put this all together and you’ve got a recipe for investor nervousness. So let’s talk about it.

Can prices get too high? Of course they can. But at the time of writing, the forward PE ratio for the US market is around 20x earnings (see SPY). The Aussie market is trading at around 15x earnings (see STW).

Now, one could argue that markets are not exactly cheap. But it's hard to argue we’re in a genuine bubble. That’s despite those same things occurring over the last 10 years: strong population growth; massive superannuation inflows; a surge in the popularity of share investing, and particularly index funds.

We’ve had a hefty crash in recent years – the nearly 30-40% fall during COVID – so it’s not like markets aren’t functioning anymore and are pushed relentlessly higher. But what about the future?

How markets (and humans) behave over time

More money pouring into the market would, all else equal, cause prices to rise further. And it’s possible that prices rise too quickly relative to earnings. In that case, active investors would start pulling money out of the market and reinvesting it elsewhere (bonds, property, other underpriced markets, etc) where a better risk-reward is present.

Think about it: if prices get so high that your potential return starts to look crummy, won’t you look at other alternatives? Of course you will. I would too. But that is typically best saved for more extreme scenarios.

In this way, markets tend to have a natural counterbalance. Prices can (and probably will) get out of hand again one day, just as they have before. But that’s nothing new. We’ve had many, many overheated markets since the beginning of stock market history. That’s true regardless of whether people are investing in individual stocks, actively managed funds, or index tracking ETFs.

Share investing has already become much more popular for everyday people in the last 10 years, as costs have come down, education has increased, and ease of use has improved (Pearler is a good example). Whether that popularity will continue or not, and whether it will have a future impact on the market, we’ll have to wait and see. But this isn’t something I’m personally concerned about. That said, I will occasionally check valuations to see if there are better places to put my money.

It’s also worth remembering one more thing. If you had blindly invested every month for the last 30 years into a diversified portfolio (all through the overvalued markets and crashes), you’d be wealthy right now. The point is, markets reward consistency and dedication more than they reward overthinking and manoeuvring.

OK, onto the next long-term risk, which is actually the opposite side of the same coin.

Risk 2: What if nobody wants to invest in shares in the future?

While some investors worry that shares will become too popular, others fear the opposite: a scenario where investing becomes less popular over time.

The thinking goes something like this: “If I’ve built a portfolio over 25 years and later I want to cash out and sell, to either buy a house, retire on the cash, whatever…then what if nobody wants to buy my shares?“

Now, you would need someone to buy those shares from you. So this could be a potential problem. But I think it’s unbelievably unlikely. Why? Well, unlike if you were trying to sell a house to retire, there aren’t just a handful of prospective buyers. There are likely many thousands of prospective buyers in the marketplace on any given week (professionals, institutions, and individuals).

So even if the total number of share investors did decline over time, there’d still be little reason to worry about liquidating a portfolio to get cash. Whether that’s to create an income stream by selling off small chunks at a time, or offloading the whole lot to use elsewhere.

As mentioned earlier, it seems more likely that share investing remains popular, and the number of people (and dollars) in the market will keep climbing. So I don’t think this is something to worry about. But there’s another way this concern manifests itself.

If shares aren’t popular, they won’t go up in value, so how will I become wealthy?

The fundamental belief at play here is that share investors are reliant on the popularity of shares to drive their gains over time. Because if other people don’t want to buy shares, then wouldn’t they stagnate in price and therefore we’d get no capital growth?

In theory, this sounds plausible, and it’s accurate to a point. After all, prices are driven by sentiment and feelings over the short term. Or, as Warren Buffett’s mentor, Ben Graham said: “In the short run, the market is a voting machine.”

But in practice, there's essentially no chance of this happening over the long run. Here’s why.

Share markets are driven higher over time, not by the popularity of shares as an asset class, but by the earnings and cashflows they create over time. Now, yes, shares have to appear attractive to have people want to invest in them. But that comes naturally due to the profitability of companies and the dividends paid to shareholders.

To finish the second half of Ben Graham’s quote in all its glory: “In the short run, the market is a voting machine, but in the long run, it is a weighing machine.” In short, the sheer bulk of money produced by companies is what causes their values (prices) to increase.

But imagine this fear does come true. Let’s say shares stagnate in price as people lose interest in the markets. Then what? Well, as time goes on and companies find ways to increase their earnings, they actually become cheaper relative to their price. Not only that, but as they continue increasing their profits and dividends over time, shares begin trading on higher and higher dividend yields. So if the Aussie market currently yields, say, 4%, that will grow to 6%, 8%, 10%, and so on, until people eventually start buying again.

At some point, it’s clear that shares would become an irresistible magnet for money. And if not, you still end up earning high returns just from income alone. So you see, shareholders don’t even need prices to increase to get a good long-term result. I genuinely don’t care if my shares go up or not. But I care a lot about whether companies are able to increase their earnings and pay me bigger dividends.

We’re ignoring the fact that professional investors (and most of us for that matter) are constantly searching for the best risk/return tradeoff we can find. This reason alone tells us that shares don’t need to be ‘popular’ in the traditional sense of that word. Even if shares are unattractive for a while (after a crash for example), eventually rationale will return and people will find the expected returns hard to resist.

Contrast this to assets like crypto, fine art, and classic cars, which are popularity based. The price is based on the perception of value, what the ‘market’ decides it’s worth. And that collective opinion is not based on underlying cashflows or dividends.

This means, if these assets don’t increase in price, your ‘return’ will effectively be zero. The long-term result is dependent on opinion and popularity. But with assets that produce income and have a fundamental growth driver to them (shares, real estate), you can earn increasing returns even without a single dollar of price growth.

Final thoughts

Remember, quite often a lot of your portfolio growth will come from receiving and reinvesting dividends. And that will come second to the amount you save and invest in the first place. Quite often, price growth is only part of your wealth, not the major driver of it.

Ultimately, these are great questions and understandable concerns to have. In fact, it’s good when investors are curious about how things are going to work in the big picture – that’s a great trait to have.

As you can see, I don’t think we have much to worry about in either case. The markets we’re investing in will have their ups and downs, no doubt. And the popularity for shares as an asset class will also fluctuate over the years. But for the most part, the future success of our investments will be based on fundamentals like earnings growth and dividends.

Now, I don’t know about you, but that gives me a sense of comfort and something tangible to focus on, rather than praying for increasing popularity and other people wanting to pay more than we did.

Until next time, happy long term investing.

Dave