Updated: Apr 1, 2020
Learn how Jessie invests his money to earn a wonderful performance passively for little fees
For the Everyday Investor
We get it, investing is a whole different world. It's not easy to feel confident in picking the right fund for your 401(k), TSP, personal investment portfolio, etc. Some of us even get a financial adviser, possibly one that we've heard is good from a family member or friend. When doing so we accept a fee to feel secure that someone, a professional, would be better off than you...but is that really the case?
This next step is difficult but it's mandatory. You need to compare yourself to a benchmark; we use the S&P500.
The act of comparing yourself to any and all benchmarks is called evaluating your opportunity costs and using the S&P500 as a benchmark is an excellent choice.
As you'll see in a moment there are a ton of fantastic investors who tout the index fund and there will be numbers below to help prove it. But if you don't ever compare yourself to an alternative, specifically the S&P500, you'll never know if you're leaving money on the table or not. This includes all the fees and taxes as well. How else would you know if what you're paying for (e.g. a financial adviser) is really giving you what you're paying for?
What the Greatest Investors Have to Say
“Most investors, both institutional and individual, will find that the best way to own common stocks (shares) is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) of the great majority of investment professionals.” - Warren Buffett
"A low-cost index fund is the most sensible equity investment for the great majority of investors" - Jack Bogle
"Investors would be far better off buying and holding an index fund than attempting to buy and sell individual securities or actively managed mutual funds" - Burton G. Malkiel
“When you look at the results on an after-fee, after-tax basis, over reasonably long periods of time, there’s almost no chance you end up beating the index fund.” - David Swensen
and the list goes on and on and on....
A Legendary Investment Bet
In one of the most acclaimed investor challenges of all time, Warren Buffett bet Protege Partners in 2007 to see who could have the best return after 10 years. Protege Partners were able to collect their greatest minds to create 5 different "funds-of-funds" to see if they can beat Buffett, the "Oracle of Omaha." Warren Buffett simply chose the S&P500 index fund and during the 2008 Recession mind you!
Furthermore on the Bet
Not only did the S&P500 beat the managed funds the S&P500 did so passively. Imagine how many hours the "funds-of-funds" managers spent picking, buying, and selling securities which could have been saved with the set it and forget it S&P500 index. The S&P500 index also didn't have to adjust for any tax or excessive fees that would usually come with the active management either.
Securities > Bonds The bet came with a million dollar cash prize. To fund the $1 million bet both parties agreed to purchase US Treasury Bonds so that after 10 years they would have $1 million to donate. In 2012 it became apparent that the return on bonds were very dismal even when the bonds matured up to 95.7% of their face value in half of the time. They made an agreement to exchange their donation to securities and ended up more than doubling their donation (Note: They exchanged it for shares in Buffett's company but it would have also been more effective to move it in the S&P500).
The SPIVA Scorecard
In Tony Robins book "Money: Master the Game" he demonstrated that the S&P500 was his personal recommendation and partnered with America's Best 401k to show how low fees and the broad index would help the regular investor achieve wonderful results. Using 15 year return data from 2001 to 2016 AB401k showed that:
The information they used came from the SPIVA Scorecard where updated information can be found here.
The Little Books With Big Importance
Another gem among books are The Little Book series. Among them are the "Little Book of Behavioral Investing" and the "Little Book of Common Sense Investing." In the former cites an annual study called the Dalbar studies which measures individual investor returns against the S&P500 and their attempt to "time the market."
"Over the last 20 years, the S&P500 has generated just over 8% on average each year. Active managers have subtracted 1 to 2 percent from this, so you might be tempted to think that individual investors in equity funds would have earned 6 to 7 percent. However, equity fund investors have managed to reduce this to a paltry 1.9 percent per annum." -James Montier
In 1970 there were 355 equity funds that existed which the "Little Book of Common Sense Investing" examines after 36 years performance. Immediately 223 are no longer around and 60 others trailed the S&P500 by 1% or more. This means 80% of those funds have already failed to beat the S&P500. Those are terrible odds! It only gets worse because 48 others are within plus or minus 1% of the S&P500 index. Of the 24 that did better than the S&P500 index 15 of them were between 1 and 2% which Jack Bogle argues could be skill, could be luck but looks into the last 9 that did 2% or better. During the study period it became known that these 9 did exceptionally well and money poured into them. As it happens, the more money that went in the harder it was to perform at the same consistency so the inevitably peaked and did not perform as well by the end of 2005. Leaving only 3, yes 3, that did beat the S&P500 over the 36 years. 3 out of the 355 funds equates to 8/10 of 1%. He leaves the reader by proposing that the performances might be great but what does that mean for the next 36 years after seeing the odds before?
Why is it So Hard If It Seems Like the Right Thing to Do?
We are human and as a human it's like us to be irrational, and fall prey to the excitement in the markets. It is incredibly hard to sit still and do nothing when there is panic or excitement around you but it's the behavior that makes great investors great. The best thing you can do for yourself is to remain rational and compare yourself to your opportunities, including the S&P500. The math might be hard, the discipline might be hard, but it's not impossible and it is necessary.
Preliminary approaches to benchmarking the S&P500 you could use is:
A historical look by looking at your purchase history and find any time you moved money into your brokerage account for investing. Use the historical S&P500 data to calculate how much you would have bought with the same amount and how much it's worth now. Account for fees and taxes.
Take a future forward approach and anytime money is used to purchase a security make a note of what the value in the S&P500 was and when the security is sold compare the returns accounting for fees, taxes, and the like. Additionally, you could use a stock trading game like wallstreetsurvivor or yahoo finance to invest equal amounts in the S&P500.
Divide your portfolio into the S&P500 and the one actively managed by you, a financial adviser, another fund, etc and split contributions between them. It doesn't have to be in equal parts if you can do the math but for most people this is the most simple and answer in your face approach.
Approach your financial adviser and ask to see the comparison between the S&P500 performance against all transactions that they make. It might cost more for their time but at least this way you'll know for sure they're doing better or worse for your money. Make sure the returns are measured annualized or at least know what they are showing you and be able to translate the difference. There are a lot of ways the numbers can be skewed.
As an Amazon Associate I earn from qualifying purchases. I would never recommend something that I, myself, would not do and can genuinely say that there is great value in these recommendations. The information on this website is not financial advice but for educational purposes only.