The past two years have been dominated by discussions about interest rates and inflation. Since most people are not economists, I thought I would try to shed a little light on why these topics are so important for your investments.
Inflation's Impact on Interest Rates
When inflation spikes like it did in 2022, interest rates would typically increase so that lenders can get a rate of return on their money that exceeds inflation. In addition, the Federal Reserve raises interest rates to attempt to slow down economic activity. The Fed is hoping that the slowdown in economic activity (demand) will stop prices from rising. Their strategy seems to be working so far in 2023 as the rate of inflation has declined significantly.
But the Federal Reserve has stated that they will not begin to decrease interest rates until the rate of inflation drops to their target rate of 2%. Currently, inflation is around 4%. The Fed has indicated that they will be maintaining their high interest rates until the end of next year.
As a result, investors are not expecting interest rates to change much over the next 12 months or until the Fed starts lowering rates.
Interest Rates and the Stock Market
Interest rates have a pretty significant impact on the stock market. Changes in interest rates often lead to changes in stock prices particularly when interest rates increase.
Let’s look at why that happens.
One reason for this is the competition among investment assets. With only so many investment dollars to go around, money invested in bonds (interest bearing assets) represents money that is not invested in stocks. When interest rates on bonds increase, they become more attractive investments than stocks. When funds move from the stock market to the bond market, stock prices tend to decrease. This is exactly what happened in 2022.
The same thing happens in reverse. If interest rates on bonds are very low, investors are drawn to the potential for higher returns in stocks. Many people think that the rapid rise in stock prices between 2010 and 2021 was partially driven by the extremely low interest rates during that time. In the previous decade, interest rates were often close to zero. Investors were almost forced into owning stocks as bonds became much less attractive.
In the 1970s, inflation and interest rates were at extremely high levels. Bonds were earning as much as 15% per year and people were taking on mortgages with interest rates in the mid-teens. Money moved out of the stock market and into the bond market in the 1970s. As a result, the stock market dropped significantly in the mid 1970s.
There is another important reason why interest rates affect stock prices. Unfortunately, it is a little complex to describe. Investors value stocks based on the projected cash flows of the businesses they represent. Future cash flows are discounted based on current long term interest rates. When interest rates are higher, the future cash flows are discounted more. Therefore, when interest rates rise, the financial value of every company’s cash flow decreases. Stock prices decline as a result.
Since technology and high growth companies have higher projected future cash flows, their stocks decrease more than other companies when interest rates increase. This is why the Nasdaq and technology stocks lost more value in 2022 compared to the S&P 500. The Nasdaq dropped 30% in 2022 while the S&P 500 dropped by 20%.
Both the S&P and the Nasdaq have rebounded nicely in 2023 even though interest rates have not decreased this year. Investors are anticipating that interest rates will be decreasing, however, and that has led to the increase in stock prices this year. Inflation has decreased significantly and that has created the expectation that interest rates will drop in the future.
CONCLUSION
The main thing you need to know from all of this is that rising interest rates are bad for stock prices and declining interest rates are generally positive for stock prices. You also need to be aware that higher growth technology stocks are more affected than slower growing stocks. The financial and economic news can be confusing, but it really is that simple as far as interest rates and stock prices are concerned.
Happy Investing,
Phil
Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
I do what I do because tens of millions of Americans are missing out on the biggest wealth building opportunity of their lives. Seventy five percent of Americans do not end up with enough money to retire at age 65. And the twenty five percent that do retire with enough money could have had millions more if they had managed their 401K investments properly. We are talking about a missed opportunity of tens of trillions of dollars in total. Do you see why I get so worked up about this issue?
THE CAUSES
There are many reasons why people are missing out. Most of them are attitudinal in nature.
We have already talked about the love/hate relationship that people have with their 401K accounts. This mainly stems from the frustration they have with their investment performance and the massive fear that people have about losing lots of money in bear market collapses. All of this is completely understandable. We provide real solutions to these issues in our program.
IT IS THE MESSAGE NOT THE MEDIUM
Today I want to talk about another big factor that is behind the poor results of 401k investors – the fact that people are totally unaware of the massive wealth building opportunity that they have with their 401k. This mainly stems from the messages that have been communicated about 401K investing.
Just about all financial advisors are cautious about the expectations they set for their clients.
THE REGULATORY ENVIRONMENT
Most of this is driven by the regulatory framework in the investment business. Financial professionals can get in big trouble if they lose lots of money in their clients’ accounts. The industry and the government have had to put in lots of regulations to try to prevent fraud and bad behavior. As usual, there have been some unintended consequences from the rules and regulations.
Did you know that financial advisors cannot advertise their investment performance results? Interesting, right? Competitive forces in most industries lead to the best performing companies gaining market share by advertising their better products and services. This is not allowed in the investment business mainly to avoid people fabricating their results.
So, financial advisors get penalized for losing people money and they can’t talk about making people lots of money. They are left to compete on safety and reputation. The advertising messages are, therefore, all about safety and reliability – not about results. It is not their fault. It is the way the industry is regulated.
A CAUTIOUS BREED
Financial professionals are also very cautious by nature. Most advisors use projected annual investment returns of around 6% per year for their clients’ retirement planning. A trained monkey can earn 6% per year with their investments. Just putting all your money in an S&P 500 index fund will earn 9% per year in the long-term. The caution is understandable, but it keeps people from seeing the real possibilities. Setting the bar very low allows the advisor’s performance to look better but it is bad for results when you manage to that low bar.
The messages they send to their clients are all about caution and the protection of their assets. Strangely, they are not very good at this. They don’t have any effective solutions to stock market crashes. Their “Buy & Hold & Suffer” strategy never feels very safe during bear market collapses, does it?
These cautious messages only add to the fear that most investors have. Everyone is starting from a place of fear. They are never told to think about the multi-million-dollar opportunity.
THE FREEDOM TO PUBLISH
This is why I am not a registered financial advisor. I am classified as a publisher. The regulations allow publishers to talk about the opportunity. I still am required to post all the industry standard disclosures on my website and in my marketing materials. But I have more freedom to talk about the massive opportunity available to all investors.
My Beyond Buy & Hold solution is all about taking on less risk because I have a real solution to those dreaded bear market collapses. My solution allows people to capture the high long-term gains of the stock market while avoiding the pain that comes with investing in the stock market. I like to think of it as having an insurance policy attached to your stock market investments. It is insurance against bear market collapses.
The industry says that people need to take on higher levels of risk to achieve higher rates of return. I disagree vehemently with that myth.
My point today is that people would do much better in their 401k accounts if they were excited about the opportunity compared to the current state of being fearful about their investments. People would engage differently with their 401k with a more positive attitude. Most people don’t even want to think about their 401k because it scares them. Attitude matters in everything in life, and it is incredibly important in investing.
I am on a mission to spread this word and to ensure that people achieve the kind of wealth that they deserve.
Seize the day with your 401k!
Happy Investing,
Phil
Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
SUMMARY:
Major Market Index funds are the best option for all investors.
Most people stop at the S&P 500 and search no further.
The Nasdaq and the Nasdaq-100 produce better results than the S&P 500, but very few people know this.
Combining Nasdaq index funds with the Beyond Buy & Hold system produces incredible results.
We already discussed the reasons why you shouldn’t own individual stocks or even mutual funds for that matter. NO stock pickers can beat the returns of the S&P 500 over long periods of time – ten years or more. Large cap US index funds (like the S&P) are the way to go. They beat small cap and mid cap funds over the long run. They beat international funds. They beat commodities. They beat bonds. Index fund owners don’t need to do any research. They don’t need to track industry trends. Investing in index funds is very simple and simpler is better than complex when it comes to investing. But which large cap index fund or funds should you own?
THE S&P 500
Index funds which track the S&P 500 index should be at the top of your list. The S&P 500 is the benchmark index that all equity fund managers and investment professionals use to measure their results. You should too. This index represents the 500 biggest and best companies in the world. Specifically, the S&P 500 contains the largest 500 companies that trade on US stock exchanges. This index is highly diversified across companies and industries. The performance of the companies in the S&P 500 reflects what is going on in the US and global economies. Over long periods of time, the S&P 500 has returned between 7% and 8% per year before dividends. Currently, the S&P 500 has a dividend payout rate of 1.8% per year. So simply owning an S&P 500 index fund will return you around 9% to 10% per year with dividends reinvested. You will not be able to beat that return by investing in your own stock picks or by investing in the stock picks of highly paid money managers via mutual funds. As far as investing in equities goes, the S&P 500 is very safe because of its diversified holdings and because of the size and strength of these companies. The value of all the S&P 500 companies represents about 70% of the value of the entire stock market. It is not immune from bear market crashes, but it will always rebound from bear market crashes and eventually reach higher price levels. For many investors, they should simple stop right here and invest only in the S&P 500.
The ticker symbols of the top index funds that track the S&P 500 are VOO, IVV and SPY. VOO and IVV have lower fees than SPY. Not all these ticker symbols are available on every brokerage platform, but at least one of them is traded on all the major trading platforms – Schwab, Fidelity, TD Ameritrade, etc.
THE NASDAQ
Investors who are looking for higher returns from a large cap index fund will want to consider investing in the Nasdaq. The two biggest stock exchanges in the US are the New York Stock Exchange and the Nasdaq. Companies that meet their financial requirements can trade their stock on either exchange. The Nasdaq composite index contains the stocks of the roughly 2,500 companies that trade on the Nasdaq exchange. While most people think of the Nasdaq as a large cap index, 30% of the Nasdaq is made up of mid cap and small cap companies. The Nasdaq is mostly large cap but not purely large cap. The main difference between the Nasdaq and the S&P 500 is that the Nasdaq contains a higher percentage of technology companies. Just over 50% of the companies that trade on the Nasdaq are technology companies. Tech companies only make up 28% of the S&P 500. Because the Nasdaq contains more exposure to smaller companies and technology companies, you get more growth in the Nasdaq vs. the S&P 500. But you also get more volatility. The Nasdaq beats the S&P 500 by about 2% per year over the long term. You can expect the Nasdaq index to grow by 9% to 10% per year compared to 7% to 8% for the S&P 500. The S&P 500 pays out dividends at a slightly higher rate, however. The current dividend ratio for the S&P is 1.5% compared to 0.8% for the Nasdaq. Including dividends, you can expect to earn about 1.5% more per year in the Nasdaq versus the S&P 500. That may not sound like much, but earning and additional 1.5% per year would generate 50% more total dollars over 30 years.
The chart below compares the performance of the S&P 500 to the Nasdaq Composite between 1986 and 2022. An investment in the Nasdaq would have generated about twice the amount of money at the end of 2022 versus the same investment in the S&P 500. But the gains were not consistent. The Nasdaq surged ahead in the late 1990’s during the dot-com bubble, but the Nasdaq gave back all those gains in the early 2000’s. From 2009 through the end of 2021, the Nasdaq significantly outperformed the S&P 500.
The greater volatility in the Nasdaq means that price peaks are higher and price valleys are lower when compared to the S&P 500. The Nasdaq tends to drop more in bear markets and tends to climb higher in bull markets. In years where the S&P 500 is declining in value, the S&P index drops by an average of 12% per year. In those same years when the S&P is declining by 12% per year, the Nasdaq is declining by 18% per year. In years where the S&P 500 is increasing in value, the S&P index grows by an average of 17% per year. In those same years when the S&P is increasing by 17% per year, the Nasdaq is gaining 24% per year. The volatility results in peaks that are 7% higher and valleys that are 6% lower. Since most people are uncomfortable with the volatility of the S&P 500 (bear markets), they tend to stay away from the Nasdaq because it is even more volatile. The extra 2% per year in additional returns is not worth the added volatility for them. In the long run, though, long-term Nasdaq investors will end up with more money vs. S&P 500 investors.
THE NASDAQ-100
The Nasdaq 100 has a similar profile to the Nasdaq Composite. It represents only the biggest 100 companies that trade on the Nasdaq. The Nasdaq-100 contains an even higher percentage of technology companies than the Nasdaq Composite and it does not contain any financial companies. The returns for the Nasdaq-100 are even higher than the Nasdaq composite and it is not any more volatile than the Nasdaq composite on the downside. While the Nasdaq composite beats the S&P 500 by about 2% per year, the Nasdaq-100 beats the S&P 500 by about 4% to 5% per year. That overperformance is very significant. Earning an additional 4.5% per year compared to the S&P 500 would generate 240% more total dollars over 30 years. In years where the S&P 500 is declining in value, the S&P index drops by an average of 12% per year. In those same years when the S&P is declining by 12% per year, the Nasdaq-100 is declining by 17% per year. In years where the S&P 500 is increasing in value, the S&P index grows by an average of 17% per year. In those same years when the S&P is increasing by 17% per year, the Nasdaq-100 is gaining 29% per year. When it lags (27% of the time), it falls short by 5% per year. When it beats the S&P (73% of the time), it wins by 12% per year. The volatility results in peaks that are 12% higher and valleys that are 5% lower. As with the Nasdaq, people tend to avoid the Nasdaq-100 due to the added volatility. But for long-term investors, people miss out on a lot of investment gains by staying away from the Nasdaq-100.
In the next chart, we add in the Nasdaq-100 to the comparison. The Nasdaq-100 stayed ahead of both indices in the 2000’s and had explosive growth after 2009. Surprisingly, most investors are not aware of the strong performance of the Nasdaq-100 index. Savvy investors are well aware of the advantages of investing in the Nasdaq-100.
There are not as many options for Nasdaq index funds. We use the ticker symbol ONEQ for the Nasdaq composite and the ticker symbol QQQ for the Nasdaq-100.
The following chart compares the value of a $10,000 starting investment at the beginning of 1986 in the S&P 500, the Nasdaq Composite, and the Nasdaq-100. You can see how significantly the Nasdaq and the Nasdaq-100 outperform the S&P 500. The Nasdaq-100 investment produced $845,000 compared to $182,000 for the S&P 500 – almost five times more money or an extra $663,000. Amazing!
| S&P 500 | Nasdaq | Nasdaq-100 |
Beginning Investment | $10,000 | $10,000 | $10,000 |
Ending Investment | $182,000 | $319,000 | $845,000 |
THE NASDAQ AND BEYOND BUY & HOLD
Since our Beyond Buy & Hold avoids most of the pain associated with bear market collapses, we are very comfortable owning Nasdaq index funds. The larger declines in bear markets for the Nasdaq when compared to the S&P 500 creates better opportunities for our system to profit by trading the Nasdaq in those bear markets. Since we go “all in” during bull market cycles, we get to reap the rewards of the higher returns of the Nasdaq and the Nasdaq 100.
Avoid the Nasdaq at your own peril. Combining the Nasdaq-100 with the Beyond Buy & Hold investing system can create incredible results for your portfolio.
Happy Investing,
Phil
Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
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