Digging deeper into long-term returns

Written by John Osbon on August 28, 2012

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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