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Investing Principles

4 Stats to Change Your Perspective on Investing

The factors that can be important to becoming a successful investor aren’t what you might think.

Articles by Morgan Housel

By Morgan Housel
Partner, Collaborative Fund  |  Published: November 30, 2018

The part of the market you watch the least matters the most.

Even in a broad index fund, most companies perform very poorly over time.

Not all investing is complicated. But it’s often not intuitive, either. That’s why a lot of people struggle with it. Most people have the intelligence to become competent investors. But many don’t, simply because the factors that can be important to becoming a successful investor aren’t what you might think.

Here are four.

The part of the market you watch the least matters the most.

In the last 100 years, the U.S. stock market has returned 10.2% per year. That turned $1 into $17,820.

But not all of that return came from the stock market going up. Most, in fact, did not.

About half the market’s long-term return has come from dividends. For those who need a refresher, dividends are a company’s profits paid out to shareholders.

The math works like this: If you just look at how much stock market prices have gone up over the last 100 years, you turn $1 into about $279. But once you add in dividends, the average annual return nearly doubles. And because of the power of compounding, doubling your annual return by including dividends in the calculation drives the long-term return exponentially higher. Literally 63-times higher, in our 100-year calculation. (You can play around with the numbers here).

The point is that dividends can seem negligibly small in the short run — you will probably never see a CNBC breaking news story that says “ExxonMobil declares second-quarter dividend” — but over your lifetime as an investor they will likely become enormously important. That’s how investing works: The boring stuff you can pay attention to over a very long period of time tends to matters more than the exciting stuff that catches your attention today.

Boring often beats bold.

The S&P 500 is made up of 11 sectors: Consumer Discretionary, Consumer Staples, Energy, Financials, Health, Industrials, Materials, Real Estate, Technology, Telecom, and Utilities.

Which sector do you think has performed the best over time?

Intuition would tell you Technology, because tech is high-growth, high-innovation, high-excitement.

But it’s not even close. Consumer Staples — food, diapers, soap toothpaste, napkins, that kind of stuff — performed best over time, and beat Technology by a long shot. And it’s done it with less volatility:

Boring (Consumer Staples) vs. Bold (Technology)

consumer staples vs. technology chart

Source: O’Shaughnessy Asset Management

The point here isn’t to go all-in on Consumer Staples and ignore Technology. Or even to favor one specific sector over time.

It’s that a diverse portfolio can be important because what drives returns over time often isn’t intuitive.

Technology (as a sector) is exciting and can grow fast, but both sectors have anchors: Excitement can increase valuations, which can reduce future returns — some times. Other times, tech does incredibly well, like over the last decade. Relying on intuition for what makes sense is a good recipe for disappointment in investing. Diversification is a hedge on the counterintuitive drivers of market returns. In other words, a portfolio that’s exposed to many sectors of the market, instead of just one or a few, allows you to participate in both the boring and the bold.

“Leave it alone” is very often the best advice, for anyone.

The S&P 500 is 500 companies. But those companies have changed tremendously over time.

A committee from Standard & Poor’s pulls companies out, replaces them with new ones, and finds new components when others are acquired. Since the index began in 1957, almost 1,000 companies have been removed from the index, and another 1,000 new companies added, according to Wharton professor Jeremy Siegel.

Siegel once calculated how the S&P 500 would have performed if, rather than replacing old companies with new ones, investors had just stuck with the original components, letting dying companies die and reinvesting proceeds from buyouts into the surviving S&P 500 companies.

It was pretty amazing.

The normal S&P 500 returned 10.3% a year from its 1957 founding through Dec. 2003, according to Jeremy Siegel’s The Future for Investors. But if you stuck with only the original 500 components, you would have earned more — 11.3% a year.

Here again, the point isn’t to try to replicate this strategy. It’s merely a reminder that fiddling, tweaking, and adjusting your portfolio in and out of new stocks can be counterproductive to the patient act of sticking with a portfolio over time.

Even in a broad index fund, most companies perform very poorly over time.

J.P. Morgan Asset Management once looked at the Russell 3000 — a broad index of 3,000 companies — and calculated how each company performed from 1980 to 2014.

The overall index itself did well over this period. It went up more than 40-fold.

But if you dig into the individual components — there were more than 13,000 of them over this period, because companies come and go — it’s chaos.

The bank created a metric called “catastrophic loss,” defined as a company losing 70% or more of its value and never recovering.

“How often does this take place?” it asks. “40% of all stocks suffered such a permanent decline from their peak value.”

Forty percent.

The reason the overall index performed well over time is because a small group of companies achieved incredible performance. But the average — median — stock in the index underperformed over time, and almost half of the stocks in the index lost money over this 34-year period.

The takeaway here is simple humility. Investing is hard. Business is hard. Picking winners is very hard. That’s why indexing is often preferable to stock picking. Investing in a diversified portfolio isn’t giving up; it’s acknowledging that capitalism is brutally good at knocking companies down and handsomely rewarding a few winners, usually with unpredictable and counterintuitive results.

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