Digging deeper into long-term returns

Last week we discovered that even in rising markets, up days barely outnumber down days (54 percent up, 46 percent down). This time let’s dig a little deeper in the numbers and see what we can learn about the pattern of equity returns and market volatility.

In the previous article (“Will the market go up or down tomorrow?”) we used data on the S&P 500 index for 1989-2008.  This time we’ve made it even more real, in three important ways. (Special thanks to my son Max Osbon for generating this data!)

  • First, we’re using data on SPY, State Street’s index ETF that tracks the S&P. Unlike the index one can actually make an investment in SPY. This data includes the (very low) management fees that owners of SPY experience.
  • Second, the results include the full reinvestment of dividends to reflect total return.
  • And third, we’re looking at the entire lifespan of the ETF, from 01/29/93 to 8/22/12.

SPY performance from inception to 8/22/2012. Source: Bloomberg.

Down is normal too

The first thing we see is that down frequency figures in the top row match the index numbers from last week very closely, even over the different time frames. The ETF was down 46 percent of days, 37 percent of months, 23 percent of years and so on. This really points to the problem faced by market timers – the market shifts around so much that trying to strategically jump in and out is like trying to jump onto a moving skateboard when you can’t be sure if it’s moving ahead or back.

The pennies add up

Second, the average daily return over the 19+ years was 0.04 percent. That’s a whopping four cent return on your hundred dollar bill every day. If someone offered you that kind of return, would you even bother to take it? Well, it sounds too tiny to matter, but for the patient investor it meant more than a 9 percent annualized return for the full period and a total return of 360 percent (220 percent of that through price appreciation, the rest through dividends). In my view that’s more support for staying invested. Missing even a few months of average returns each year would mean forgoing very significant returns over time.

Expect some suffering

Third, gain is often paid for with pain. In its best one-year period, SPY posted a 72 percent gain. But owners of the ETF also experienced big annual declines, including one of 47 agonizing percent. Interestingly, over longer periods the maximum gains have been much larger but the largest declines have not. For instance, the best five-year period produced a total return of 250 percent; the worst five-year loss was a relatively small 35 percent.

The moral of the story

Now we know for certain that future gains and losses in SPY will not mirror the last 19 years exactly. What we do know is that patient investors who bought SPY when it first became available have earned a tidy total return while enduring many discouraging declines, some that lasted many years.

Like it or not, stocks – even those of big blue chip companies like those in the S&P 500 – can and do go down. But over long periods, the overall historical direction has been up. For instance, the Dow Jones Industrial Average stood at approximately 100 during World War II and at 1000 in 1983. It is now over 13,000, not including the significant boost provided by reinvestment of dividends.

You can get a little dizzy when you go deep in the data, but once in a while I think it’s a good idea to let numbers tell us a good story about patience.

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This article may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.

Nothing in this article is intended to be or should be construed as individualized investment advice. All content is of a general nature. Individual investors should consult their investment adviser, accountant, and/or attorney for specifically tailored advice.

Any references to third-party data or opinions are listed for informational purposes only and have not been verified for accuracy by the Adviser. Adviser does not endorse the statements, services or performance of any third-party vendor without specifically assessing the suitability of a third-party to a client’s or a prospective client’s needs and objectives.

Inclusion of index information is not intended to suggest that its performance is equivalent or similar to that of the historical investments whose returns are presented or that investment with our firm is an absolute alternative to investments in the index (if such investment were possible).  Investors should be aware that the referenced benchmark funds may have a different composition, volatility, risk, investment philosophy, holding times, and/or other investment-related factors that may affect the benchmark funds’ ultimate performance results.  Therefore, an investor’s individual results may vary significantly from the benchmark’s performance. 

Specific securities identified and described may or may not be held in portfolios managed by the Adviser and do not represent all of the securities purchased, sold, or recommended for advisory clients.  The reader should not assume that investments in the securities identified and discussed were or will be profitable.   Any securities identified were not selected based on their performance but as an illustrative tool for demonstrating volatility of equity markets.



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