WHY THE STOCK MARKET ALWAYS WINS

When you invest in the stock market through an index fund representing the S&P 500, you can be extremely confident that the value of that investment will grow significantly in the long term. You can be much more confident in the value of your stock market investment increasing than you can be in the value of commodities or real estate increasing in the long term. You can be much more confident in the value of the S&P 500 increasing than you can be of the value of any specific individual stock. Why is that necessarily true?

When we refer to the “stock market” in this article, we are referring to the S&P 500 – the index that represents the 500 largest and best companies in the world. We are not referring to individual stocks or specific mutual funds or sector funds. The S&P 500 is the best representation of the broad stock market because of its size and its diversity.

The first factor to consider is the history of asset prices. The stock market has delivered higher investment gains than all other asset classes over long periods of time (30 years or more). The S&P 500 has returned between 9% and 10% per year over the last 50 years when you include dividends. Dividend payouts are lower now than they were in the past so future expectations should be closer to 9% than to 10%, but that is still a very good return. Bond yields have averaged between 5% and 6% per year for the last several decades, but I would expect bonds to pay only 4% to 5% per year in the future. No commodity has consistently returned anywhere near 10% per year over the past several decades.

But as we are often told, past performance is no guarantee of future results, right? How can we be so sure of the gains from the stock market in the future? What do stocks have going for them compared to the other asset classes?

Our entire political and socio-economic system is designed for the companies in the stock market to succeed. Let’s look at the incentives that help to propel the stock market higher:

1. All 500 companies in the S&P index have tremendous incentives to grow. The management, the board members, the shareholders, and the employees have huge incentives in place for those companies to be successful.

2. Local, state, and national governments are incentivized for those companies to grow. Tax revenues and job opportunities benefit all government entities.

3. The general population (voters) wants good paying jobs in their communities.

4. Investment capital flows to growing and successful companies.

While the same incentives are there for individual companies to succeed, the same argument doesn’t hold up when we are talking about the stocks of individual companies. Diversification allows us to be extremely confident in the S&P 500. In any year or any time period, we see a mix of company performance and stock performance within the 500 companies in the S&P index. The growth of the market in any period is typically driven by only about 25% of the companies in the index. That means that 75% of the companies in the S&P 500 index typically underperform the market average. And in different time periods, we see different companies driving the growth. Looking out 30 years or more, history suggests that half the companies in the S&P 500 will not be around. No one can be certain about which companies will survive and which one will not.

The S&P 500 contains companies from all the biggest and most important sectors of our economy. The index has a nice mix of financial companies, industrial companies, technology companies, consumer goods companies, health care companies, pharmaceutical companies, etc. When one major sector struggles there is typically another sector that performs very well. When you own an index fund representing the S&P 500, you get both individual company diversification and you get industry sector diversification.

The same incentives that drive the stock market are not in place for bonds, or commodities, or real estate. Most people would prefer that the price of commodities and real estate remain constant or even go down. Consumers and governments don’t like price increases. Look no further than the inflation challenges we face right now. Most people would prefer that interest rates on bonds were lower rather than higher. Higher rates limit borrowing which inhibits growth in the economy. There are plenty of people who benefit when prices increase but they are in the minority.

The market seems to be very comfortable with bond rates around 4% to 5% over the long term. Investors are comfortable with this return rate for the level of risk associated with bonds. Since there is much higher risk associated with stock investments, investors seem to be comfortable with stock market returns being roughly double the returns of bonds (stock returns of 8% to 10% vs. bond returns of 4% to 5%). If stock returns get too close to bond returns, there is no incentive to invest in stocks.

The other factor to consider is innovation. It is innovation and productivity that drive the increase in value in companies and, therefore, the stock market. We have created a highly innovative and productive economy and I see no reason for that to slow down in the future. One could argue that innovation is accelerating rather than slowing down.

The only thing that could get in the way of the 8% to 9% continued annual growth of the stock market is a collapse of our political system. Given the events of the last five years, one can’t totally rule that out. But even in the most extreme situation of political upheaval, the same incentives for market growth will still be in place. There is way too much money at stake. Major political disruption would have a big, short-term effect on the stock market but after a period of time, the stock market will continue growing.

Our Beyond Buy & Hold system protects investors from major, short-term collapses regardless of the reason. Everyone needs an investing strategy like our Beyond Buy & Hold system to protect against the inevitable, short-term disruptions to the stock market. People need a better approach than simply “Riding it Out”.

The best investment strategy for long term growth is built upon investments in index funds representing the S&P 500 and the Nasdaq. Our entire political and economic system is designed to support the healthy growth of the stock market. You can be extremely confident in achieving long-term returns 8% to 9% per year even accounting for short-term bear market collapse like the one we are going through right now. Combining a market index investing strategy with a risk-based trading strategy like our Beyond Buy & Hold system will get you even higher returns.

Happy investing,

Phil

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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.