1. What is the largest ETF in the world?
2. How long has this ETF been in existence?
3. Do you know where you can get free price data for this ETF for your own analysis?
4. In the WAI workbook on pages 36 to 74, Section 2 of the workbook is about "Investing in Exchange Traded Funds". Have you tried to perform an independent analysis of the results presented there to get an independent view of what's being presented?
5. How much does markets really go up over the "long term"? How "long" is this long term?
6. How much does market "fall" over the "short term"?
7. If the average monthly return from staying invested is x%, how large is x%?
8. How much can actual monthly returns vary from x%?
9. If there are 10 different investors starting to invest at different times, what % of investors whose actual returns will approach x%?
10. If you are thinking of becoming an investor, would you still stick to the long term investing plan if your actual returns is negative after 3, 6 or 12 months?
Introducing SPY
SPY is the S&P500 Exchange Traded Fund (ETF) managed by State Street Global Advisors. It is the largest ETF in the world - the latest Assets Under Management (AUM) is around US$177 billion. It is clearly the most popular ETF in the world, as measured by the average daily trading volume. The fund seeks to provide investment results that, before expenses, generally correspond to the price and yield performance of the S&P 500 Index, by holding common stocks belonging to the S&P500 index with similar weights. Free sites like Yahoo! Finance provides decent introduction to SPY per below:
Only 22 Years Old
Interestingly, the first prices available is from Jan month-end, 1993, when the ETF first started. I studied many subjects in university including Finance, but it wasn't taught then as I graduated in 1990. From my perspective, ETF is a relatively recent phenomena.
You can get free historical price data from the Yahoo! Finance website, under the "Historical Prices" tab. To be an independent investor and trader, I strongly recommend you to use this feature to perform you own analysis of stock prices. It will give you a lot more "colour" to what Adam teaches in the WAI course, as well as what anyone taught or said about stocks and finance.
0.83% Average Monthly Returns
Between Jan 1993 to May 2015, there are 269 month-end prices with 268 monthly returns. 268 months is equal to 22 years and 4 months. The average of the 268 monthly returns is approximately 0.83% per month. So, if you are able to buy the ETF using a single lump sum 22 years 4 month ago and hold it till today, then, you can expect to earn 0.83% per month throughout that 22 years 4 month period. This looks small, but isn't shabby since 0.83% monthly returns is approximately 10% returns per year. It sure beats F.D. rates by a long mile.
Buy & Hold is extremely unpopular
In practice, there are extremely few people who is able to buy and own SPY for 22 years. Speaking for myself, I have known hundreds (or over a thousand) of investors and traders over my lifetime (real life, and over the Internet), however, I am sad to say that I still don't know any single person in my entire life that had owned SPY for 22 years! I do know a handful of people who owned stocks like Public Bank for over 4 decades, but these people are very few and a rarity. I find this to be the biggest gap between "theory" and "practice".
Volatility is not what you think
With an average monthly returns of 0.83%, how much volatility are you willing to tolerate? For example, are you willing to suffer a temporary period of zero gains to earn 0.83% long term? Do you have the stomach to suffer a temporary loss of 0.83% (instead of a gain of 0.83%)?
There are many research in Behavioural Finance surrounding this topic. One of which is called "Loss Aversion" / "Prospect Theory", which basically describes people's tendency to strongly prefer avoiding losses to acquiring gains. (For more information, see here, here and here). Most studies suggest that losses are twice as powerful, psychologically, as gains. There are many implications, one of which is that the "average person" typically doesn't want to lose more than 0.42% per month, to seek an average gain of 0.83% per month.
Does this describe you?
If so, I have bad news for you. You are psychologically not yet ready to become a long term investor in SPY (or a long term investor in any stocks). It doesn't mean you can't become one, it means you will need to change your mindset and beliefs (including the ones you are not conscious of) about stock market investing to be a successful long term investor, and how successful you are (to change your deeply held conscious and unconscious beliefs) depends on you.
Beliefs can be improved with time and "experience"
In my personal observation, too many new investors (whether young or old) approach investing with little knowledge, little experience, little hard data, and a lot (or a little) of preconceived ideas based on what they've gathered during their lifetime. Most of the preconceived ideas tend to be popularized by the mass media, friends, family who are also influenced by similar medium. There are very few independent investors and traders willing to do their own concrete research. It is understandable, because this takes work and effort.
Independent back-testing can help develop and speed up "experience" considerably
If you wish to gain financial independence as an investor or a trader, I cannot emphasize strongly enough how important it is to be independent, and to be able to do your own research including"back-testing". "Back-testing" refers to the act of analysing the past to learn how a particular investing/trading. Here, it would typically involve downloading the 22 years of historical SPY prices and do your own analysis of what you can expect every month, over the past 22 years, if you had bought and hold SPY. As you walk through the experience month by month, over the 22 years, you will have reaped much of the benefits of 22 years of investing experience perhaps in just 1 afternoon of analysis. I have personally found this sort of exercise to be much more insightful, than sitting passively in a class listening to what others have to say about this topic, because one is "active" and "experiential", whereas the other is "passive".
4.20% Standard Deviation of Monthly Returns
The standard deviation of the 268 monthly returns (which you can calculate using Excel very easily) is 4.20%. What does this mean when the Average Monthly return is 0.83%?
Actual Returns is very rarely Average
In fact, less than 10% of the time actual returns falls within 50% of Average to 150% of Average.
What this means is that if the Average Monthly Returns = 0.83%, 50% = 0.42% and 150% = 1.25%.
In other words, it is VERY RARE for actual monthly returns to fall within 0.42% and 1.25%!
How rare?
Over the past 268 months, the number of times this has actually happened is only 25 out of 268 times.
Vast Majority of the Time, Actual Returns are much higher or much lower than Average
In other words, the vast majority of the time, actual returns exceeded this range (0.42% to 1.25%)! If you are a betting man, you would win 9 out of 10 times by betting that the actual monthly returns will "significantly differ" than the long term average, outside 50%-150% of Average Monthly Returns!
Long Term Investing Edge is Very Small on a Monthly Basis
4.20% standard deviation (SD) means we can roughly expect two-thirds of the time, the actual returns to fall within +/- 1 SD from the mean.
Mean - 1SD = 0.83% - 4.20% = minus 3.37%.
Mean + 1SD = 0.83% + 4.20% = +5.04%.
This means, around 2/3rds of the time, we can expect actual returns to fluctuate between -3.37% to +5.04%.
This is a huge gap in monthly returns, around 8.4% gap in one month! In contrast, 0.83% looks extremely small in comparison!
To earn 0.83% per month, you must have the stomach to tolerate volatility of at least 10 times or more, or tolerate a gap of 8.4% per month.
Think about this for a moment.
What does Behavioural Finance say about Loss Aversion? Most people cannot tolerate a loss of just 50% of expected returns. Yet, the stock market reality is that 90% of the time, actual returns will exceed 50% range of expected returns. Do you now have some insight as to why investing (buy and hold) is so difficult for the vast majority of people who does not have the necessary "experience"?
Actual Return Distribution
Below is the actual distribution of monthly returns, by 10 groups.
Group 5 is 50%-100% of the Average Monthly Returns, between 0.42%-0.83%.
Group 6 = 100% to 150% of Average Monthly Returns, between 0.83%-1.25%.
Without looking at the graph below, how frequent do you expect returns to fall in Group 1 and Group 10, i.e. for the actual monthly returns to be far away from "average"?
Volatility is not what you expect
When average monthly returns is 0.83% over 22 years and 4 months, they don't expect that the vast majority of the time, actual monthly returns will be either bigger than 2.5% or less than negative 0.83%. (the 2 peaks for Group 1 and Group 10).
In fact, it is extremely rare for Actual Returns to be "near" Average returns from the often quoted studies popularized by the media, investment books, investing courses, etc..
This is not a criticism of the WAI workbook, in fact, I think it gives very good basics, but it is highly doubtful that any trading or investing course will show you this specific graph.
The reality of investing is that volatility is not what you think nor what you expect, unless you have done your own independent "back-testing", or have 22 years and 4 months of actual SPY investing.
(Advanced note: if you are an Options trader, notice how the distribution of actual monthly returns is NOT "normally distributed", but have extreme "fat tails" and is "skewed").
Actual Monthly Returns over 268 months
On the downside, notice the 2 big spike down, the first minus 14% and the second minus 17%. Both far bigger than the 0.83% monthly average. On the upside, notice the one time when it spiked up higher than 10%, to be closer to +11%. All these are returns over 1 month.
Returns from the stock market is definitely NOT flat-line.
(Advanced note: If you think TA or FA can predict future returns all the time like the above, you might want to retest your ability from back-testing a lot more charts or stocks picked randomly. The best analysis tend to be successful when the sample size is heavily filtered and not all cases like above. In addition, they may provide only a small edge and not a very large one when filtered).
Implications to Buy and Hold Investor wannabes
One can learn a lot from Warren Buffett here, who totally understand the above stock market reality.
1. If you want to be a true investor, you need to be able to ignore the daily and monthly fluctuations.
This is not surprising because as you can see from the hard data above, the fluctuations are wild, and serves no useful purpose for a Buy and Hold investor (except during extreme times, for him to take advantage of).
2. You must stay focus on the long term.
Long term is often measured in a decade or longer. Often, your monthly results will not resemble anything remotely close to what you can expect over the long term. This is why long term investing is so difficult to vast majority of people who mistakenly expects their monthly returns to be "close" to the long term average. They tend to give up too soon when they experience normal and expected setbacks.
3. You must embrace large deviations from the long term average.
You must not be too euphoric when you are up 200% higher than long term average.
You must not be too depressed when you are 200% lower than long term average.
You simply do what Warren Buffett does, which is to tune out the noise.
As far as you are concerned, even if the stock market closes for 5 years, you are not bothered, but just stick to your investment plan, including your regular deposits, and your regular annual/semi-annual rebalancing, or any other strategic actions that you need to take as an investor consistent to your sound Investing Plan.
4. If you don't own a portfolio of 500 top companies, expect your volatility to be even larger.
Remember that this result is for SPY, and assumes you own a highly diversified portfolio of 500 of the Top companies in the U.S. with typically global operations. Anything less diversified, or less than the top stocks will more likely have much larger volatility.
5. The same type of investor investing in the same instrument starting at different months will experience substantially different results.
Consider the following investors who starts at different months:
5a. Start in Jan 1994: Subsequent monthly returns = 3.49%, -2.92%, -4.19% ... already negative after the first 3 months, and nothing remotely close to 0.83% per month.
5b. Start in Jan 1995: Monthly returns = 3.36%, 4.08%, 2.78%, 2.96%, 3.97%, 2.02%, 3.22% for the first 7 months. This investor must be euphoric, because for 7 months in a row, he earned much higher than 0.83% per month average. He must think he has superior market timing or superior investing ability.
5c. Start in Apr 1998: Monthly returns = 1.28%, -2.08%, +4.26%, -1.35% and get this, -14.12%!! If this Buy and Hold investor does not have the right psychology, a single panic is likely to undo all his past investing.
You get the idea. These 3 investors can do the same analysis, invest in the same instrument called SPY, invest the same $ amount, but if they start at different times, they will get very, very different results.
In fact, it is safe to say that even though the "average" monthly returns = 0.83%, practically nobody gets this "average" returns. The volatility in the stock market is so high that odds are 90% of investors out there will get a substantially different result than "average".
Conclusion
I think there is so much information above, that different people can take away different conclusions.
For me, my take-aways from doing this independent study is as follows:
1. Buy and Hold investing in SPY does provide a small edge (+0.83% monthly returns) which can add up over the very long term.
2. However, it is not easy to do, due to its very high volatility, and vast majority of the time, the actual investor result will be substantially different than the historical long term average, depending on the start date.
3. They will only approach the long term average if they are patient enough to own SPY for decades. Their performance cannot be measured in months or even years.
4. Investing in SPY implicitly requires long term faith in the US stock market over the next few decades. If they do not have faith in the US economy long term, they will not be able to successfully invests in the US stock market successfully long term.
5. Discipline is paramount - just one small act of weakness during panic can undo many years of investing. The investor is often better off ignoring the daily and monthly noise, even the quarterly noises. This can be extremely hard to do for most people with significant sums of monies invested in the stock market.
6. Never blindly trust anyone when it comes to the stock market. Do your own independent research. Listen, but validate for yourself.
7. If you lack the necessary experience, you can speed up your own growth and development by doing your own independent back-testing, to gather the necessary month-by-month or day-by-day experience over very long investing/trading periods in a short afternoon or weekend.
8. There's always a lot more things to learn from the stock market than you think. You don't know what you don't know, and this is more a personal note to me than anything else.
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