S&P 500 Index Fund Saving

[ggbutcher]

I'm a real fan of index fund investing for the average person; it seems to me to be the only viable way for folks who don't have business-type education or experience to reliably save for retirement. However, I think it's not enough to get folks to just start pitching into a fund, they need to be motivated to stay the course. So, I got some S&P 500 performance data (Compound Annual Growth Rate (CAGR), 1871-2014, from CAGR of the Stock Market: Annualized Returns of the S&P 500) and did some what-if rates of return for various terms using sequences from the data. Let me know if this is a previously presented exercise, but it was very insightful to my thinking.

I wrote a perl script (yeah, I'm that old) that takes a particular investment duration, say 10 years, and starts with the earliest year in the data, works up an average rate of return for the subsequent period, does the same thing for the next earliest year, and proceeds until it can't fit a 10-year sequence in the remaining years. Here's the outcomes for 10, 20, 30, and 40-year sequences:

Years	Cases	AvgRoR	StdDev
10	134	11.91%	26.43%
20	124	11.61%	10.45%
30	114	11.54%	5.27%
40	104	11.4%	4.13%

The average rate of return is simply the average of the individual S%P 500 CAGRs for each of the x years in the sequence. I was surprised to find the consistency in the rates for each of 10, 20, 30, and 40-year sequences, but I knew there had to be a discriminator. So, I added a standard deviation calculation and ta-da!, there's the difference. If you're not familiar with standard deviation, it tells you how "collected" the data you're averaging is, around the average. Specifically, if you add and subtract the standard deviation from the average, you get two numbers within which about 67% of the data resides.

So, for the 10-year average of 11.91%, 67% of the returns fall between -14.52% and 38.34%. Yes, some of the outcomes are negative. But, for the 20, 30, and 40-year runs, 67% of the outcomes are positive (well, for 20 years, only by a little). The takeaway from this is that, the longer you let your money sit in a S&P 500 fund, the greater your chances for a greater return. When I talk to young folk about this, I tend to use a 5% expected RoR, and that seems to fit in a conservative assessment that a 30-year period gives you a 67% chance of 5% or greater on your investment.

So, it's not quite enough to point folks at an index fund, they also need to be cognizant of the need to keep the investment there for a rather long time. I think telling them that you need to bake your investment for 30 or more years to have a high chance of scoring a 5% rate of return is something they can start to understand, maybe... ?

Your comments and insights are most welcome...

 

[ETFs_Rule]

Index fund investing isn't just for the average person. I think it's the best choice for even experienced investors. I mean the pros can't beat the indexes after fees so why would the average Joe?

 

[dallas27]

are your number inflation adjusted, and are they including dividends?

 

[rayinpenn]

S&P 500 Index Fund Saving

I am a business educated person and I'm all about indexes.. I do own some single stocks but we owned them forever... Now it's all about indexes - I like "set it and forget it." Investing.

Have you read transparent investing the whole story? (PDF available online free).
http://www.transparentinvesting.com/uploads/wholestory.pdf

Sent from my iPad using Early Retirement Forum

 

[ronin]

Well I'll be skewed in my kurtosis.

 

[Surewhitey]

Just getting tired of managing stuff. Put all the bills on autopilot, why not the same for savings? Just started with SCHD & BIV...

 

[karluk]

I am primarily an index fund investor, so there is little convincing needed where I'm concerned. However, just to play devil's advocate, I find your statistical analysis to be highly unlikely to convince anybody to stay the course when stocks are plummeting and there seems to be no bottom in sight. Look at your 30 year numbers, for example. True, they indicate that after most 30 year holding periods investors will reap decent to excellent returns. But take a look at the worst case scenario. There is a 95% chance that returns will fall within two standard deviations from the mean. That means that there is a 2.5% chance that returns will be worse than two standard deviations below the mean. For 30 year holding periods, this means that there is a 2.5% chance that returns will be worse than 11.54 - 2*5.27 = 1%. This small worst case chance of giving back most or all of their profits is what drives investors to attempt market timing during bear markets - usually with disastrous results.

This forum is certainly not immune. I haven't seen a market timing thread recently, but as soon as the market takes a downward turn I know they will be sprouting up, just as surely as dandelions in springtime.

 

[frayne]

Index investor here and I hope everyone else is trying to beat the market with managed funds.

 

[hnzw_rui]

Index investor here and I hope everyone else is trying to beat the market with managed funds.

Lol, same. Without folks actively trading, index fund investing wouldn't work so well.

 

[ETFs_Rule]

Lol, same. Without folks actively trading, index fund investing wouldn't work so well.

All I care about is myself. I'm beating everyone else with my index funds.

 

[ggbutcher]

I am primarily an index fund investor, so there is little convincing needed where I'm concerned. However, just to play devil's advocate, I find your statistical analysis to be highly unlikely to convince anybody to stay the course when stocks are plummeting and there seems to be no bottom in sight. Look at your 30 year numbers, for example. True, they indicate that after most 30 year holding periods investors will reap decent to excellent returns. But take a look at the worst case scenario. There is a 95% chance that returns will fall within two standard deviations from the mean. That means that there is a 2.5% chance that returns will be worse than two standard deviations below the mean. For 30 year holding periods, this means that there is a 2.5% chance that returns will be worse than 11.54 - 2*5.27 = 1%. This small worst case chance of giving back most or all of their profits is what drives investors to attempt market timing during bear markets - usually with disastrous results.

This forum is certainly not immune. I haven't seen a market timing thread recently, but as soon as the market takes a downward turn I know they will be sprouting up, just as surely as dandelions in springtime.

Thanks for the insight. As I posted, I realized that one standard deviation really didn't give good confidence, and you're right, two standard deviations introduces the possibility of less-than-inflation pacing in some outcomes. Still, the possibility lowers as you increase the time you let the investment "bake".

I have a personal anectodal account of this working; a front-end load mutual fund I bought when I was stupider than I am now. Thirty years later, I've much more than recovered the load, for a net rate of return of about 9%, all because I just about forgot about it. How can we teach this sort of thing?

 

[UnrealizedPotential]

Thanks for the insight. As I posted, I realized that one standard deviation really didn't give good confidence, and you're right, two standard deviations introduces the possibility of less-than-inflation pacing in some outcomes. Still, the possibility lowers as you increase the time you let the investment "bake".

I have a personal anectodal account of this working; a front-end load mutual fund I bought when I was stupider than I am now. Thirty years later, I've much more than recovered the load, for a net rate of return of about 9%, all because I just about forgot about it. How can we teach this sort of thing?

How can we teach this ? Not too well imo. Atleast I have not had much success reaching out to others. I think a bigger issue is how to get people to save any money at all from their paycheck.

 

[nash031]

Index investor here and I hope everyone else is trying to beat the market with managed funds.

+1! We need people to continue believing they can consistently beat the market.

 

[ETFs_Rule]

+1! We need people to continue believing they can consistently beat the market.

There always will be. Some people believe they are beating the market with managed funds even though all they are doing is taking on more risk and happened to do so during a bull market.