Introduction to Investing: Article #2
In the previous post we set a few simple ground rules when it comes to investing, namely select the investment that offers the highest compounding rate of return and let time do the rest. So naturally, the next question is where do we find the highest rate of return?
The answer is quite straightforward.
It is easy to conclude where to invest when you see the graph above. Over the last 50 years, the S&P 500 has outperformed debt, US housing, and even gold by a significant margin. There are of course countless options when it comes to where you invest your money but for simplicity, we selected four of the most common investment instruments accessible to most people.
US House Prices
Most people consider owning a house an important investment and therefore was included in our analysis. Based on the above however we would argue a house is not an investment at all if you are trying to maximize your wealth. Another option is to own a portfolio of real estate assets instead, but interestingly general real estate returns over the last 50 years are lower than housing returns in the US. You also must consider how many real estate assets you could effectively manage without giving up your day job.
Gold is often spoken about as an important asset class to invest in especially during turbulent times. Looking at the returns from investing in gold over the last 50 years, it is better than housing but not the best option to choose from.
You will often hear financial advisors instructing you to put a portion of your investments into bond instruments as they tend to offer safe, stable returns. We, therefore, looked at the US 3-month T-Bill, the US Treasury bond, and corporate debt returns over the last 50 years. Corporate bonds were by far the highest return of the three, as you would expect, but fall far short when searching for optimal returns.
We included the S&P 500 in our analysis because, well, this is the subject of our discussion. We used the S&P 500 Total return for the last 50 years. The total return includes the return from reinvesting any dividends you would have received from the listed companies you were invested in over that period. The return excluding reinvesting dividends still outperforms housing, gold, and corporate debt but is significantly lower than the total S&P return. Interestingly, since 1926 dividends contributed 32% of the total return of the S&P 500 while capital appreciation has contributed 68%. (Source: S&P Global)
Maybe we have rigged the outcome by picking the last 50 years, you say! Okay well, let us look at the last 40, 30, 20, and 10-year returns to be fair.
It is clear from the above that the S&P has significantly outperformed all other asset classes over the last 50, 40, 30, 20, and 10 years. EXCEPT for Gold over the last 20 years, however, the S&P wasn’t far behind. We don’t however, think it is wise to conclude gold is a better investment based on its slight outperformance over the last 20 years but significantly underperforming other periods.
So what can we conclude from this?
We believe it is safe to say that the stock exchange offers the best returns available over the long-term by quite a wide margin and therefore if we are looking to maximise our returns then surely that should be where we invest. We are now in a position to add to our set of rules;
To optimise your returns invest in the stock market
Reinvest dividends you receive back into the market.
Other asset classes
What about oil you say? What about platinum? What about private equity? What about……? AND of course, what above Cryptocurrencies.
There are endless options available when it comes to investing. We chose the most common and most accessible to the everyday person but if you have an advantage in a certain area, say you have the ability to invest in high-quality non-listed businesses, we encourage you to explore that. But for us, and most people, the best option is going to be the stock market.
With regards to cryptocurrencies, the returns over the last 10 years are outrageous smashing any asset class you could have picked however cryptocurrencies are in their infancy so we will happily include them in our analysis after it has been around for another 10, 20, 30 and 40 years. For us, it hasn’t been around long enough to feel comfortable with either its longevity or ability to outperform other asset classes in the long term. We also do not understand it nor do we know how to value it. We are therefore happy to miss out. Of course, if you feel you have an edge in this space then maybe crypto is the investment for you.
Other advantages of the stock market
Besides the optimum returns the market offers, there are other advantages too, below are just a few;
Allows individuals to take ownership of a business:
Buying a single share in a company means you become part-owner of that business. The stock exchange is by far the easiest way to become an owner of a company.
The liquidity of trading on a stock exchange cannot be matched allowing individuals to buy and sell shares within seconds of each other. This means you can take ownership of a company within seconds and sell your shares without any concerns, compare this to owning property that can take weeks, months, or even years to liquidate.
Large selection of individual investments:
The New York Stock Exchange and Nasdaq alone have over 6,000 listings to choose from.
Previously we established that if our goal is to create wealth over the long term then the need to invest in instruments providing compounding rates of return and we need to invest in these instruments for as long as possible.
Here we have established that the best returns which are easily accessible to the general public, are found by investing in the S&P 500 far outperforming other common assets classes especially if we reinvest the dividends we receive from these investments. It is important to note that the returns are not in a straight line and you are going to have good years and bad years but if the past is anything to go on then the good years are going to far outweigh the bad and you should do very well, but only when you invest for the long-term.