Why Invest Forever? (Part 4)

Key Points

  • Although the worst-case outcomes for the investing in the S&P 500® Index seem uninviting, the index has provided reasonable returns the vast majority of the time.
  • The worst-case 5-year holding period for the index produced an annualized real return of -13.233%; however, over 80% of the time the 5-year holding period produced a positive real (inflation-adjusted) return.
  • Further, the worst-case 45-year holding period for the index produced an annualized real return of only about 3.5%; however, 90% of the time the 45-year holding period produced a solid annualized real return of close to 5% or better.

Alternative View, Same Data

A rigorous study of the long-term returns of the S&P 500® Index yields an understanding that the index, on average can provide passive investors with favorable returns in the range of 6-7% per year on average including dividends, even after adjusting for inflation, but before taxes and fees. In Part 3 of this series, we studied various holding periods for this index ranging from 5 years to 45 years and noted that the longer the holding period, the lower the chances of losing money, and the greater the chances of hitting this 6-7% average, inflation-adjusted return. So if you’re investing for retirement, or even Investing Forever, all the better. Nevertheless, the worst-case outcomes for the index are, at first sight poor (as we’ll review again in Table 2 below).

In Table 1 below, we provide an alternative way of dissecting the same data that we studied in Part 3, so let’s see what else we can infer based about this alternative vantage point.

2018-12-23-Why Invest Forever (Part 3) Table 2
Table 1. Decile Analysis for Rolling-Period S&P 500® Index Annual Returns 1871-2018 (dividends reinvested and inflation adjusted). (Source: DQYDJ)

The 45 Year column includes all of the inflation-adjusted returns of the S&P 500® Index for each 45 year period starting from 1871 and going through 2018, rolling forward one month at a time.

The first row, labeled 90%, signifies that 90% of the returns for a given column are greater than or equal to this value. For example, 90% of the time the 45 Year real return for the index was greater than or equal to 4.918% over this historical period.

Similarly, 10% of the time the 45 year real return was greater than or equal to 8.086%; and 50% of the time the 45 year real return was greater than or equal to 6.138% (which represents the mathematical median of this holding period).

In Table 2 below, for reference purposes we show the minimum and maximum annualized real returns for a given holding period.

2018-12-31-Why Invest Forever (Part 4) Table 2
Table 2. Rolling Period Minimum/Maximum Returns of S&P 500® Index returns 1871-2018 (dividends reinvested and inflation adjusted). (Source: DQYDJ)

Again, these tables were created from an online calculator provided by DQYDJ, so feel free to play around with my assumptions in order to explore on your own. Further, the data for this analysis goes back to 1871, well before the S&P 500® Index was created so there has been some extrapolation and interpretation done on the part of DQYDJ in order to assemble and analyze this particular dataset.

Insight Time

From this alternative view of the rolling-period data we can draw some additional insights.

  1. Although the worst-case, 5-year annualized real return is significantly negative at -13.233%, 80% of the time, the 5-year return is positive.
  2. And although the worst-case, 15-year annualized real return is negative at -2.133%, 90% of the time, the 15-year return is positive.
  3. And although the worst-case, 45-year annualized real return seems unimpressive at 3.539%, 90% of the time, the 45-year return is greater than or equal to 4.918%.

So even though the worst-case holding periods for the S&P 500® Index seem unappealing, for any given holding period, 90% of the time, the annualized real returns of the index are not as bad as one would think. But for added color on this point, in Part 5 of this series we’ll begin to provide some insight into just how much wealth we might generate based upon some of these various outcomes for the index.