Investing in financial markets is risky, as with any investment opportunity there is a chance to make or lose money. The average return in the S&P 500 over the last 95 years is between 10 and 11%.
Key Points
- Between now and 1926 average returns on the S&P 500 are approximately 10%.
- In 83 out of 123 years investors would have made money.
- Highest returns where 47% in 1955, lowest returns where -46% in 1932.
Does investing in individual stocks make you rich?
A couple of recent examples highlight the difficulties of investing in particular stocks/assets. The infamous son of a Russian Oligarch lost fifty million US dollars a day trading in financial markets. However, even with less extreme cases an interesting piece from the Hendrik Bessembinder at Arizona State University, shows that nearly 60% of stocks listed on US stock exchanges have lower returns than government bonds (which are very low). It is also pointed out that just 4% of listed companies explain the gain for the entire U.S. stock market since 1926. With this kind of information, investing in individual stocks is off-putting.
So What's the Problem?
The issue investing in one stock is risky. It is easy to find examples of stocks that would have made you a millionaire IF you invested a reasonable stake 20 years ago, but it is much easier to find stocks that would have made you lose your entire investment. Let’s take two examples from the turbulent times of the COVID-19 crisis with a short illustrative case.
First, Investor A has a small portfolio of stocks, interested in foreign travel the investor is attracted to large airline stocks. They hold a portfolio concentrated in a small number of firms with a large proportion of their investment in AeroA (a hypothetical airline operator), a company that the investor has worked for, for 20 years. Over the last five years, things have been going well, the investor is very contempt with the returns and with an initial investment of buying at $333/share, returns have climbed steadily. However, in March 2019, when it was apparent that COVID-19 would reach all corners of the world, Investor A’s position fell dramatically, not only are they worried about future job prospects, but they have also lost a considerable amount of their investment in AeroA, shares have dropped to less than 100$/share. Whilst this example is hypothetical, many examples can be found with a quick Google search.
On the other hand, Investor B likes to spread risks across many different companies, whilst using a small portion of their investment on speculative trades. A large majority of Investor B’s portfolio is the S&P 500, the largest listed company in America. Like Investor A, Investor B worked for an airline operator and was worried about future job prospects. However, investing in the S&P 500 has been turbulent but less risky compared with Investor A. The S&P 500 fell sharply following the COVID-19 news but has since recovered leaving Investor B with a healthy return in 2020.
But why Did The S&P 500 Recover and AeroA Not?
Our hypothetical example again has the advantage of hindsight. However, the message that the S&P 500 is a robust investment vehicle stands. Winners and losers from the pandemic are contained within the index. It is less risky when the misfortunes of one company are supplemented by the fortunes of another. This is the advantage of investing in a larger portfolio of stocks, which with ETFs is much more realistic for novice investors.
On Average How Much Would I Have Made?
As is shown in the figure of the Annual return, positive returns are much more likely than negative returns when investing in a large index like the S&P 500.
Disclaimer
Information within this piece has been produced with reasonable care, however, the information contained within the document is for illustrative purposes only.
Infamous link: Russian oligarch’s son racked up $50m in day trading losses | Financial Times (ft.com)
