

How long is a 'long term investment'? (a brief analysis of S&P500 since 1950) - tomsaffell
http://saffell.wordpress.com/2008/10/25/snp500/

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mattmaroon
He's missing dividends. The average S&P 500 dividend yield is 1.37% according
to something I just found on Motley Fool. If that's accurate, that's pretty
substantial.

Too bad they didn't have SPDRs in 1950, he could have been much more accurate
with the same amount of effort.

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tomsaffell
Good point. I would like to analyze returns assuming re-invested dividends
(TSR), which I will try to do in my next analysis. However, as I search around
the web I'm having trouble finding enough data (SPDRs only go back to '93, and
even the economagic data only starts in 1970, which isn't really enough data
to meaningfully look at 'average' 30 year investments)

Does anyone have access to data going further back? I will continue looking
myself, maybe also looking at DJI data.

In the spirit of _hypothesis lead analysis_ , perhaps we (or I) should lay out
hypotheses for how the TSR analysis will differ (Total Shareholder Return).
Clearly the curves will be shifted to the right, probably by the ~1.37% that
Matt mentions. But what about the variance? (which is more interesting IMO). I
need to think about that..

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bokonist
Here is a dataset that includes the value of the S&P and dividends, going back
to the 1800's. <http://www.econ.yale.edu/~shiller/data.htm>

The dividend yield used to be much higher, the long term average is 4-5%. The
current yield of 2% is pitiful. Dividends are really how you make money
investing in stocks, the price appreciation is really just a proxy for money
supply growth, see <http://www.cashflowanalytics.com/news.php?articleID=172>.
You can get that same kind of appreciation investing in gold, art, 1950's
baseball cards - anything that people value and find hard to dilute.

I've wondered if the appreciation of the S&P index takes into account the
constant reweighting that needs to be done. For instance, there's a lag as the
company falls out of the index and when a mutual fund can actually sell it.
I've also wondered if it takes into account the dilution rate of stocks, which
traditionally has been around 2% a year.

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tomsaffell
Excellent - thanks for the link. I'll redo the analysis with the new data.

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marvin
There are lots of interesting things to consider here. Thanks for putting this
together, it set me thinking.

The analysis doesn't consider investment over time - as far as I can tell,
this graph shows the probability distribution of returns on a one-time
investment after a period of years. The goal of investing long-term is to
dampen the effect of investing at a (in retrospect) very good or very bad
time. (In addition, of course, you need to put your money somewhere to get
returns at all).

Random oscillations can be dampened further by investing at regular intervals,
disregarding what the stock price is at the moment: for instance, investing a
smaller amount every month for five years (or even every month, period). It
would be interesting to see how the probabilities of such an investment scheme
fares against a savings account.

You could even make two probability distributions: one for stock market
returns and one for savings account returns, considering taxes where they
apply. (In my part of the world, income from savings accounts is taxed
annually while returns on stock is only taxed when the gains are realized,
which affects returns over time substantially). Inflation affects all
investments equally, and could be disregarded.

Now that I think of it, maybe I should do this myself. This is exactly the
kind of investment scheme I am betting on for the next 20 years, so it seems a
bit irresponsible not to do this kind of thing beforehand.

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gamble
Investing a lump sum by spreading it out over a period of time ('dollar cost
averaging') has been shown to produce lower returns than making one large
initial investment. Most experts regard it as a marketing gimmick used to ease
nervous customers into investments.

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nostrademons
That assumes that you have all the money in the beginning, correct? Makes
perfect sense in that case - the market goes up on average, so if you invest
early on, you get a better price.

But most people don't have a large pile of money sitting around, and earn it
over time. AFAICT, dollar-cost-averaging gives you a better return than the
alternatives of buying a certain number of shares monthly, buying the best
performing stocks, or holding all the cash and investing it when you think
it's a good time to invest.

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gamble
Yes, the term 'dollar-cost averaging' tends to be overloaded. Strictly
speaking, it refers to a strategy where you start with a lump sum and invest
it in chunks over a period of time, rather than at once. Some people have
extended the concept to periodic investments, like you might make in a 401k.
In that case, there's really no reason to sit on your money rather than
investing it as you go.

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mixmax
One of the flaws in this is that since he's looking back in time he doesn't
include potential investments in companies that go bankrupt. This would shift
the whole thing somewhat to the left.

Interesting nonetheless.

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mattmaroon
I don't see how that matters. You can and maybe should just invest in SPDRs.

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mixmax
OK, here is the explanation. Maybe it isn't as obvious as I thought.

Let's say that you invest in 100 random stocks in 1978 and intend to keep them
as a long term investment. In 2008 when you want to sell your stock it has on
average risen by x%. But some of the companies you invested in have gone
bankrupt, and thus these shares are worth nothing. This pulls your entire
portfolio down by quite a bit.

Now if you look back from 2008 instead of looking forward from 1978 you will
see a different picture. If you pick 100 random stocks and see what their
stockprice was in 1978 (which is what this guy seems to have done) you might
expect to get the same result, but you don't. A lot of companies have gone
bankrupt in those 30 years, and you don't include these in your back-looking
portfolio. Yet, as we see these days, it is a real scenario that the company
you have invested in will simply tank and your shares will be worth nothing.
Over thirty years my guess is that 3 out of 100 companies will go bankrupt,
meaning that bankruptcies alone diminishes your portfolios value by 3%.

I think this is quite substabtial.

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tomsaffell
This is an interesting point. The analysis was done on the 'index value' of
the S&P 500 (from Yahoo Finance), not on any individual equities. I'm trying
to discover how long a 'long term investment' need be, if one invests in an
S&P 500 index / ETF / iShare. (I'm no expert on the subtleties of those
investment vehicles). My understanding is that they track (as best they can)
the value of the index by investing in the stocks that compose the index.
Therefore I _guess_ that when company in the S&P 500 goes bust the effect that
has on one's investment closely matches the effect it has on index value. I'll
research that. Assuming this is true, I think we needn’t be concerned by the
bankruptcy issue that you make. But please correct me if I'm wrong about that
- I'm interested.

I'll try to add TSR in the next analysis too.

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mattmaroon
It's not interesting, it's just wrong. Even if the total market averages 10%,
that's counting bankruptcies. It's not a median or a mode, it's a mean.

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mixmax
Matt, you're right. I thought he was looking at a portfolio of individual
stock, not an index where bankruptcies are supposedly included.

My bad...

