The Green Swan eBook
Hello again, folks! Thanks for checking in with The Green Swan. Before I get to today’s post, Invest to Win, I have a big announcement to share. The Green Swan ebook is published and ready to go! The Green Swan eBook is over 30,000 words, 82 pages on normal 8.5 x 11 paper, and over a year in the making to help you get on the path toward financial independence! To find out more, visit The Green Swan eBook page.
Invest to Win
Now, back to today’s post. Today we will be getting into some nitty gritty of The Green Swan’s key principle #3: Investing. And what I’m going to show you today is how to invest to win! Check this link out for a refresher on The Green Swan’s Key Principles. Otherwise, let’s dive right in.
I have received a number of inquiries from readers as to the composition of my investment portfolio and why I feel comfortable investing in stocks. For background, my wife and I have held an all stock portfolio, comprised of a variety of mutual funds (both domestic and international), since we began investing out of college approximately 10 years ago.
In this post I’ll explain why I am comfortable with an all stock portfolio and why I think that is the best way to invest to win. In a follow-up post, I will go into the composition of my actual portfolio and why I’ve structured it the way I have.
Yes I know, just because something happened historically doesn’t mean it will continue to be the case in the future. Thanks Einstein, but Is that still not the best indicator? So let’s look at some common investment vehicles to see how they have fared historically. I’ve selected a 30 year time horizon for no real particular reason other than 1) that’s the most recent data, 2) it is a long enough time horizon to flush out some noise in the numbers and give a more accurate representation, and 3) I’m 30 years old so why not.
Sorry, I’m not sorry, this post is going to be data intensive. What did you expect though in a post on investing!?
The below chart shows the returns on an annual basis for the S&P 500, Treasury Inflation Protected Securities (TIPS), 10-Yr Treasuries, Total Corporate Bonds, and Total Commodities. S&P returns are total returns as provided by ychart.com, while the source for the data on the other securities is from portfoliovisualizer.com.
At the bottom I summarize the data with the High, Low and Average returns over the 30 year period. From this chart, I draw two conclusions:
- The average S&P return outperforms all other securities by a landslide. The difference between the S&P and commodities of 3.5% per year adds up over 30 years.
- Although the S&P has stronger returns on average, the ride is bumpy with significantly more volatility (as indicated by the high and low returns).
So my conclusion is that if you have a long time horizon, the S&P 500 is your best investment. Shocker, huh?! Like you haven’t heard that before. But let’s dig deeper into the S&P 500 return to see what else we can conclude.
S&P 500 Detailed Return Analysis
The chart below details the S&P returns with more detail. Column 1 is the annual return and the next column over marks the value of $1 from the beginning of 1986 onward (based on those annual returns). Column 3-5 are the 5 year, 10 year, and 15 year compound annual growth rates (CAGRs). These CAGRs are calculated on a rolling basis. For example, the 5 Year CAGR in 1986 of 19.87% represents the average return from 1981-1986, or the 5 preceding years. Likewise, the 15 Year CAGR in 1986 of 10.76% is calculated based on the returns from 1971-1986.
Again, at the bottom I summarize the data with the High, Low and Average returns over the 30 year period. A lot of data, I know, but let’s break it down a bit by drawing out my main conclusions from this chart.
- The value of $1 at the beginning of 1986 grows to $19.32, or said differently, if you invested $10K at the beginning of 1986 you would have $193.2K by the end of 2015! Talk about putting your money to work for you!
- Out of all 30 5-year investment horizons, only 5 are negative (2002-2004, 2008, and 2011). Yes stocks are volatile, but for a relatively short time horizon of 5 years you have a 84% chance of either breaking even or better. That should give you some degree of confidence to maintain a significant amount of stocks up to within 5 years of your planned retirement date, or even well into retirement.
- Let’s stay focused on the 5-year CAGRs, because it only gets better when looking at the longer time horizons of 10 and 15 years. The worst 5-year investment period was down only 2.3%, and that was after 3 consecutive bad years from 2001-2003. What that tells me is that even when there is a lot of pain in the stock market, it bounces back relatively quickly to close to breakeven. So expect pain, yes, but also expect a good bounce back quickly after (so stick it out!).
S&P 500 Linked Returns
This chart does not tell the whole picture though, so one last chart. Hang in there, you can do it, just one more!
The chart below shows what I call the “linked returns” of the S&P 500. I’m not sure if this is an actual thing or not, but it makes sense to me. This measures what I feel is the true value of the $1 invested in 1986. While the average returns do a good job of showing just that, the averages, I think it smooths things out too much. We all know that if the stock market drops 50% one year, your $1 goes to 50 cents. And even if it goes back up 50% the next year you are still only at 75 cents, whereas the average return would be 0%. Alternatively, the linked return measures the return based on the dollar value.
So the chart below shows the linked returns based on the value of the $1 over the previous 10 year, 20 year, and 30 year periods up to 2015 (i.e. the 10-year linked return is from 2006-2015).
Still solid returns over these investment horizons. I would note that although the 10-year linked return is only 7.31%, that period is negatively impacted by the timing of the annual returns, specifically the largest single year drop in the S&P500 since the great depression, which occurred in the 3rd year of this period (2008 drop of 37%).
- The stock market has the best historical return performance than any other asset class
- Historical returns is the best proxy for future returns, even though it does not guarantee it
- While the stock market is more volatile in any given year, the 5 year returns are much less volatile with a low probability of loss
- There is even less of a likelihood of loss over 10 and 15 year periods
In terms of how this relates to asset allocation in retirement, if you are comfortable with any given 5 year period being slightly below breakeven on a worst case basis, you could consider having about 5 years’ worth of expenses in more liquid and safe assets and have comfort that the rest of your portfolio in stocks will at least hold their value pretty well. Keeping in mind that is the worst case, while the far more likely outcome of your stock portfolio in any given 5 year period will have average annual growth of over 11%!
But asset allocation in retirement is a whole other discussion which I will leave for a future date. In the next post you will see more specifically what my portfolio is comprised of and why I’ve constructed it the way I have.
This article was the result of reader inquiry so I appreciate the comments! To further the discussion, let me know if you have considered an all-stock portfolio and why/why not? And, of course, if you disagree with the analysis or conclusions above let me know.
Thanks for taking a look!
The Green Swan
Work Harder, Work Smarter, Retire Earlier and Find Your Beach
Disclaimer: Please reference my Disclosures page. This post is for informational purposes only and is not to be construed as financial advice. If you need help with investing or financial decisions, please consult a financial professional.