I hope everyone had a very good long weekend. This week we take our first look at what returns to expect from our investment strategy, buying the S&P 500 ETF, and how it compares to other investing strategies.
THE WEEKLY PULSE
Last week we discussed that this economic crisis is first and foremost a health crisis, the numbers we first need to follow are the daily case counts. Over the last week Canada has begun to see a steady decline (outside of Quebec) which has led to the first phase of reopening in many of the provinces. Whether this is too early or not and whether we need to quarantine again will become clear with time, but for now, we want to know how bad our economy has become.
This week, we turn to retail sales. Retail sales covers, among other things, the sale of all products you can find in a mall or that you buy via e-commerce. It also covers gas sales, travel, hotels, and even the sale of garden supplies. For many, it is one of the main indicators that can inform us of the health of our economy.
The more we spend, the more jobs are needed. The more jobs we have, the more people have money. The more people have money, the more money is spent.
Retail sales are key because it shows how much we are spending. The more we spend, the more jobs are needed. The more jobs we have, the more people have money. The more people have money, the more money is spent. This circle of spending makes up the majority of our economy. Our spending contributes to the salaries of jobs that create, sell, and market the products we buy. It pays the taxes for our cities to operate. And, our spending is the primary profit driver for the companies that make up our stock market.
To see the gain or loss in our spending, we use the below graph to give us some historical context on the severity of the situation. This graph illustrates the monthly percent change in retail sales (our spending) over the last 30 years with the decline for the month of April very clear on the right side of the graph:
What we are seeing, in the United States, is a 16% drop in retail sales between March and April. We don’t need to dig much into the data to see that this is an unprecedented drop in spending, which, as we have highlighted, means an unprecedented drop in our economy.
As we begin to re-open, this will be one of the most important data points to follow. How quickly our economy bounces back will be a key indicator for the severity of this crisis. The longer it takes to bounce back to a sustainable level, the more risk we have moving forward over the long term, and the more cautious we need to be in our financial strategy.
TAKING A LOOK AT OUR RETURNS
There are many different investment strategies. Some involve the frequent buying and selling of stocks. Some buy many different indices, like the S&P 500 index, to own stock markets around the world. Some rely on computers to analyze data and make decisions for us. Our strategy is simple: we are buying and holding one thing: the S&P 500 Index ETF.
We were asked this week how good of a strategy this is. To determine how good the strategy is we need to answer two questions:
How much money are we going to make: What is our Expected Return?
How does our expected return compare to other strategies?
To determine how much money we expect to make – our expected return - we have to look at the history of what we are investing in. We use historical returns to give us an average annual return forecast to create expectations for our future returns. Below is a chart showing the returns from the S&P 500 over the last 40 years:
As we can see in this graph, there is a very clear direction for the green line – it goes up. If you dive into the numbers behind the graph, it tells us that on average, you can expect to make 5-7% a year using this strategy. We also observe that the timing of your investment plays a large part in determining your overall return. Recall from May 3, the second gold rule of investing: you cannot time the market. This is why we invest in tranches, especially in a period of uncertainty. We spread out our buying to account for the possibility of significant drops in the market while also making sure we do not miss the gains in the market.
Now that we know the returns we can expect, we need to know if other investment strategies, such as buying individual stocks, would do any better. To determine that we compare our strategy to the strategy of the industry’s best investors - hedge funds.
The hedge fund industry exists to offer investment options that provide the best returns in the business while limiting your risk (we will discuss risk in greater detail in future articles). They are, in many cases, the best of the best at everything from picking stocks to buying debt. We can safely assume that they, having unlimited resources, large teams and billions to invest, will likely do a better job than we can at buying stocks.
Warren Buffet over the last 12 years has continuously told the average investor to just own the S&P 500. He is so confident in this single strategy that at the height of the last crisis, in 2008, he made a blind bet for $1,000,000 that no hedge fund manager, over a ten-year period, could get better actual returns than the S&P 500. This means he bet every hedge fund professional in the world, that no matter what strategy they used, they would not make more money than if you just bought the S&P 500 Index ETF. Only one hedge fund manager took that bet. Poor Ted Seides. In 2008 he and Warren Buffet made a one million dollar bet that his hedge fund returns would beat the S&P 500. His strategy was to combine 5 different investment strategies in a single portfolio. After 9 years he wrote: “For all intents and purposes, the game is over. I lost.” To see by how much he lost we take a look at the graph below. The blue bar represents the S&P 500 and the red bar as his returns:
The S&P 500 not only did better, it did way better. More than that, by only one hedge fund manager taking the bet it seems that many of us actually know the S&P 500 will do better on a return basis (the benefit of the risk reduction is again something we will talk about in the future). These are the best stock pickers in the world. The best traders. The ones who watch their screen all day and every day and yet, our simple strategy of buying the S&P 500 will often be as good – if not better.
We are working to take control of our financial health. Going forward we don’t know if the S&P 500 will return the same results it did over the last ten years, but given its history of going up, and its comparison to some of the best strategies in the world coming out of the last crisis, we can be sure our strategy is a good one. We can also be sure we can do it ourselves.
I want to thank the reader who submitted this week’s question on return and hope that today’s article has shed some light on what to expect and why we are doing it. We are investing 20% in a strategy that has been a proven winner not just because our expected return is 5-7%, but because that expected return is much better than many of the alternative strategies out there.
This community will build because of your questions. Tell us what you’re interested in most. Are you looking to invest? Wondering the risk of your industry or company? Want to learn about the property market? Leave us a comment or send us a note and we will answer that question for you.
Disclaimer: The New Norm is written to provide actionable advice and stimulate financial questions in an effort to increase the financial health of the community. Your decisions are yours alone and we do not take responsibility for your actions. Please think long and hard before making financial transactions and know that past results are not indicative of future returns. There is always a risk when you are investing.