My Favorite Investment Chart

I typically pull this chart out after a 10% market decline, when people are panicking, to show how common we see this and to calm people down.  It also seems like a good reminder right now.  If you are interested in hundreds of charts explaining what is going on with the market, I strongly suggest the JP Morgan:  Guide to the Markets.  It’s awesome, but this following chart is my favorite.  


It’s not all that intuitive, but the chart shows two things.  The dark gray bars are the S&P 500 index return for each year since 1980.  The red dot below each gray bar is the maximum draw-down that same year in the S&P 500.  For example, last year the S&P 500 index was up 19% and the biggest peak to trough drop last year was all of 3%.  

So, why do I love this chart so much?  This chart shows just how hard it is to be a good investor.  

Now, I’m not talking about how difficult it is to “beat” the market.  There are thousands of studies that show just how hard it is for professional money managers to do better than their index.  This chart shows just how hard it is for average investors to do as well as the market.  It appears investing is easy.  Buy and hold a simple S&P 500 Index fund since 1980, and you would have only lost money in 8 of the past 38 years  Even more amazing, you would have only had one losing year in the past 15 (I’m not counting 2015, in which the index was slightly negative, but you would have been positive if including dividends).  Honestly, just looking at the gray bars, and you would think that this investing stuff is pretty easy.  Unfortunately, it is the red dots below that crush the average investor.  

If you would have bought an S&P 500 index fund in January 1980, you would have earned nearly 13% per year over the past 38 years through 2017. If that is the case shouldn’t we just all buy the index and forget about financial advisors? Yes, but getting these numbers aren’t as easy as it sounds. To get this 13% annual returns, you would have had to withstand an average annual correction of nearly 14%. On top of the annual volatility, you would have had to hold through eight greater than 19% corrections and four 30% corrections. You would have also been comfortable holding your investment even though you saw your account lose more than 50% of its value in 2008 and 2009.

Investing is hard, and most investors are awful at timing the market correctly.  The S&P 500 index has done great over the long-term, investors haven’t.  The chart below shows how well investors have performed owning the Vanguard S&P 500 index vs. how well the actual Vanguard S&P 500 index fund has performed.

Investment vs. Investor Returns.pngSource:  Morningstar

Look how well investors did last year, nearly matching the returns of the index. Last year was one of the easiest years to invest in the past 38 years. The stock market only had a maximum drawdown of 3%, which is only the second time in the past 38 years which we have had such low volatility. Therefore, it was very easy to just buy and hold and never get nervous and sell your investment early. Now, look at the 10-year number. The average investor only had half of the return of the stock market! Of course, the main reason that investors have done so poorly over the past 10 years, was the huge downturn in 2008 and 2009 which caused many investors to sell at the wrong time, and not benefit when the stock market rallied.

So, what is the main investing lesson here and why do I love these charts so much? Investing in a year like last year is easy.  When the stock market goes straight up with no volatility, anyone can and should do well. It’s important to understand that last year is an outlier and not the norm. Are you prepared for a 14% drop in the stock market? This isn’t a prediction, rather an average over the long-term. I have seen too many people get more aggressive or remove downside protection, such as fixed income, from their portfolio because how easy things have been over the past couple years. If you are also going to sell if you see a 14% drop in your portfolio, you are setting yourself up for long-term under performance.

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