November 2023
They dissect the common belief that the average annual return of the stock market over the long-term is around 9-10%. The market experiences fluctuations, sometimes delivering very positive and negative returns. Therefore, investors should not expect a consistent 9-10% return year after year in the stock market and must maintain along-term perspective.
Bruce and Chris also go over historical investment returns, with small value stocks showing the most significant growth over nearly a century. A dollar that was invested in large-cap stocks 98 years ago would have grown to about $11,000 by now, while it would have grown to about $128,000 if invested in small-value stocks. Chris and Bruce encourage investors to properly diversify their portfolios and consider if they’re exposed to these areas of the market. Additionally, they discuss the evolving investment landscape, particularly the rise of income-generating investments like fixed-income and private lending, due to changing interest rates.
Ep. 57 AI, Bias, and Financial Decision-Making
Ep. 56 Can We Thrive Amidst Uncertainty: War, Rising Rates, and Political Chaos
Hello, everybody, And thank you for joining us for another episode of THE FINANCIAL COMMUTE. I'm your host, Chris Galeski, joined by Partner and Wealth Advisor Bruce Tyson. Bruce, thanks for joining us.
Glad to be here.
Interesting year in the markets. I think we've had some bank failures. We had a debt debacle. We had a government shutdown. We've had headlines about inflation and interest rates. Affordability with housing and employment seems to be all over the place.
And going back to your very first comment, it's always interesting. I mean, I'm not sure I know you know this, but while the average for the long term average for the stock market is like nine or 10% a year, going back way back, it almost never is nine or 10%. It's either 12 or 15 or 20 or down three or down 25.
So averages, as I've heard recently, it's like if you have your head in the freezer and your feet in boiling water, on average, you're pretty comfortable.
I think that puts the average returns of the stock market in better perspective. Right. Because it's very rarely. Exactly. You know, that 9 to 10% that it historically is return. Right. It's either a lot higher or a lot lower or somewhere in between. But that analogy of putting your head in the freezer and your feet in boiling water, the average is correct.
You're probably comfortable, Right.
Another interesting statistic is... If you look at your portfolio every day. Your daily chance of being up is 53%. So 47% it's down. But on a quarterly basis, it's up 71%. And on a yearly basis, market's up 78%.
So people can worry a lot on a day to day basis, but just takes longer overall perspective to have more comfort being in markets.
Warren Buffett even said recently that, you know, there's always reasons why not to invest, right? I like how you put it in perspective in terms of if you look at your accounts daily, there's a 50% chance, 53% chance that it's up. If you look at it quarterly, I think it was close to 70%. And then if you look at it on an annual basis, about 78% of the time.
Right. You know, you made money with regard to stocks. We do most of our stock investing with a group called Dimensional Fund Advisors. And they had a speaker come into the office last week that threw out some just mind blowing statistic. Right. That I just found really interesting. So he threw one example out there saying, okay, listen, you always have to gauge this risk versus return with clients.
Average return for the stock market is, you know, nine or 10%, like you said. But it really hits that number. You can have big extreme from year to year. Right. And so that's why, you know, people also invest in bonds. Right. But going back to 1926, if you invested a dollar into T-bills over that, call it almost 100 years, that $1 earning that 3 to 4% of your return over that, you know, almost hundred years that would be $22.
That's more than a ten bag. That's a 22 bagger. Right. Over a hundred years.
I mean, I invest a dollar in 1926 and I have $22 today. I'm not sure that that necessarily kept up with the inflation rate. That's not really worked out. And then he said, okay, well, what about large stocks? So, you know, the last 15 years, large mega-cap technology stocks have been the place to be, Right. So if you invested a dollar in 1926 in the large stocks, what would it have grown to?
$11,000.
$11,000. So you got bonds 3 to 4% on average go. $1 goes to 22, $22. $22. Yeah. Then you've got large cap stocks, average returns, call it 8 to 10%. That $1 grew to 11,000. Right. That's an incredible difference.
And if you think that that's interesting, you know, a lot of people sit there and say, well, you should be invested in smaller companies in value. Right. And the last 15 years that might not have worked out that well for you compared to large growth. But if you invested a dollar in small company stocks, 1926, you know, it would be worth something like $40,000, Right?
But then small value, what was small value?
It was over $100,000, 120 then $128,000. That's incredible.
I mean, let's get this straight, right?
Tell me again why I shouldn't put all my money in small cap value.
That's probably a lot more volatile. Yeah.
If you can deal with the, you know, 60 to 70% swing sooner, I'm that's that might be even more extreme. But I mean, that's just that's an amazing difference because of compounding. Right. So T-bills very safe investment $1 turns to $22. Right. Large cap stocks, $1 turns into around 11,000. Small cap stocks, $1 turns into like 40 something thousand.
And then small value stocks. $1 turns into 128,000 over the last 98 years. Right. That's incredible. That's one of the reasons why we choose to work with a group like Dimensional Fund Advisors. They do, you know, focus on the long term effects of things. They also try to tilt their portfolios towards more value oriented companies, companies that are cheaper relative to other companies, but then also are a little bit smaller as well.
Right. So people, you know, in the last 15 years, obviously growth has done a lot better than value and people think that value has been off its game, which it has not. It's really been pretty consistent in it, and it's priced in its valuation metric, which is priced generally price to book. It's been fairly costant in the two times plus or -2 to 3 sometimes, whereas growth has been just huge numbers up and then crashing back down.
You know, in the first decade of the 2000s, actually value did pretty well compared to, you know, growth stocks.
And that was right after sort of that technology boom. Right. So the tech bubble bursts. Right. And so growth companies, you know, lost 90% of its value overnight. Right. But that's more of the extreme that we're talking about, is that, you know, both growth and both value have done very, very well over the long term. Right. But because growth can get to such high extremes from a valuation standpoint, Right.
That eventually they come they could come crashing down in price. But value companies, they're already perceived to be cheaper. Right. They also have higher profitability, more cash flow.
Often higher dividend.
Higher dividends. Those seem to hold its price and be a lot more steady over time.
Right. If you think about some companies now that are available in the value space, you can see a lot of energy companies like Exxon and Chevron have, you know, 4% approximate dividends. Their price to earnings ratio is only like ten as opposed to some of the big, you know, more aggressive tech companies, which can be, you know, in the 100 times earnings range.
Yeah. And so if you know, depending on what you're looking for, if you're trying, you're rich and you want to take a chance, you know, maybe go with some of that. But a lot of your money in the growth stuff at these levels. But really, you know, we're more comfortable in, you know, the consistent, you know, conservative value plays for part of the portfolio where we can get those lower valuations, but higher cash flows.
I mean, you've been investing and helping clients make decisions around investing for, you know, just a few years now and you've seen a number of different things go on.
Just a few years?
Few years, or just a few. But you happen to see a number of different instances where, you know, the economy has been good or it's also been challenging. Aside from the tech bubble, where if I just created a website, I had $1,000,000,000 valuation. Have you ever seen the market this interesting in terms of, you know, seven or eight companies leading the way versus everywhere else to sort of chugging along?
You had that back in the in the tech boom. Where you know it's seven or eight companies, you know, can be a third or, you know, 30% of the valuation of the S&P 500. Yeah, that's pretty extreme. But sometimes it's ten or 15. It's usually the bottom part of the markets.
I mean, in terms of the indices and, you know, they don't get much playing the top allocations and the S&P 500 are more like the top one company, each one of those is more than the bottom 100 of the S&P 500. Right. They just get actually almost no impact.
No exposure.
Yeah, I think even earlier this year, the Nasdaq, the top six companies represented almost half of the index itself. Right. So if there was 100 companies that index. Right. Seven of them represented 50% of it. I mean, that can just get really out of whack when it comes to where do I want to invest my next dollar?
Right. And then at what price? What am I investing in? Is it a good price or is it expensive?
Right. So, you know, as investors were now, you know, facing the ongoing question of, like, where should we put money? And nowadays, because of what's happened with the economy, there are a lot of juicier investments in income generating investments that are some traditional fixed income and some also what we call private credit, where yields can be in the 8 to 10% range.
And that is crowding out. I think that's one reason why why the average stock has not done that well. I mean, this year and we're talking in November that the equal weight index for the S&P 500 is or if you had a dollar, every company in a $500 investment, that's actually slightly negative this year.
So even though the S&P 500 is up, you know the average company’s not. And so we'd just as soon be in investments where we're getting positive return and when income investments like this are attractive then big pension funds and other initial very large investors can say, hey, I can get my bogey from doing this without having to take as much risk.
So a lot of money goes there and that puts a damper on, I think, where growth stocks, you know, can go. I think if a value company is dealing 4% and you can crank out 3% or 4% capital appreciation which isn't very much right. That's an 8% return.
Sure. That's pretty good, right? Almost. That's almost the the long term average of the stock market.
And this is really the shift of the tide that has happened over the last couple of years with higher interest rates and the Fed kind of coming in, stepping in. And, you know, just to kind of summarize it for everybody. Post the financial crisis, we basically had instituted a zero interest rate policy. Right. Meaning that we as an economy are going to keep interest rates as low as possible.
The Fed was setting that wrote those rates to instill economic activity. Right. And so you had a period of time where the dividend yield on call it the S&P 500. Well, you were getting more income from the dividends than you could going in, buying a bond. Right. And so you kind of had the best of both worlds during that time.
You could invest in growth and get more income than if you were to go to income oriented investments. And that caused just a flood of money to go focus on growth. Right. Whether it was real estate assets were, you know, or growth stocks, but all that money, because it wasn't there, it was getting paid. You were earning less.
So it all went there. Now, all of a sudden, rates are at a reasonable situation.
And by the way, that income from rates is contractual. That's a big deal.
They have to pay it. Yeah. Yeah. So now all of a sudden, in those contractual agreements, those loans, whether it be private credit or other types of fixed income, you can get that 8, 9%. Well, if the dividend yield in the S&P 500 is still around two or less, less, it is It's probably like 1.3 or 1.4. Right.
Now all of a sudden it's like, wow, I can get a really good return outside. I don't need stocks to do this. And so, you know, money flows make a big difference in terms of, you know, things being able to go up. Right. Yeah, That's know, it's so fascinating. It'll be really interesting to see how this plays out.
But you were talking to me earlier that because of the change in rates and the competition for investments, whether it be private credit, public credit versus stocks- that can cause a slowdown in the economy.
Right. The government borrowing is crowding out the other investments. So we as investors putting, you know, now T-bills are 5% so we can buy a lot of T-bills and other then other private investments that require funding and loans. You know, we're putting money in those kinds of things, too, and that's crowding out money that might otherwise go into something that private equity or building companies.
And because banks are not lending as much, banks’ lending requirements are super strict. Now it's harder to get capital. And that's a function of the government, you know, borrowing so much money.
I'm still just blown away by the numbers. It's really easy to kind of look at it day to day and have that fear of missing out. Right. I want to be invested in, you know, the Apples, in the Microsoft and the Tesla. This is not an endorsement, by the way, but I want to be invested in those seven companies because that's what's driving all the growth this year.
But if you look over the long term, you know, the difference between investing in small cap value versus, you know, large cap like that, right. A dollar over almost a hundred years could grow to 11,000 or 128,000. Right. I mean, it really makes you think in want to look at your portfolio and say, hey, am I properly exposed to that area of the market?
Am I properly diversified? And, you know, should I maybe take some chips off the table from these things that have done really, really well? All right.
And that's why you should take good care of your health so that you can live to be 100 years old and have that money and grow your own leg.
I'm glad that you brought that up. I actually came across this article over the weekend. It was talking about blue zones. And in Japan, a lot of those blue zone places, they live by this philosophy of ikigai. You know, you what you are meant to do in life. And they say stay active, don't retire late, be involved in something that you're passionate about and take it slow.
Don't fill your stomach, get in shape, smile, reconnect with nature, give thanks. Live in the moment. These are all things that you know are great to live by. And it's not, you know, checking your account every single day and worried necessarily about, you know, recessions and, you know, volatility in the stock world.
Well, actually, I came across something just yesterday.
Drink tea and nourish life with the first sip joy with the second thankfulness with the third Danish.
I like the Danish part.
And then another one. Be patient and achieve all things. Be impatient and achieve all things faster.
Bruce, thanks for joining us today. I know that investing in, you know, stocks or bonds or in general is really difficult to, you know, put some rationale behind where do I go next? Where's my next dollar best suited? And sometimes we just get so focused on what's happening today or in the short term that we need to kind of zoom out and say, hey, where is it that we're really trying to go, when is this done?
Or what am I hoping this will do for me for the long term and just not sell all the things that are kind of doing okay and just buy more of the things that are doing really, really well and that incense, you might be missing out on a tremendous amount of growth for yourself and your family long term.
Disclosure: Information presented herein is for discussion and illustrative purposes only. The views and opinions expressed by the speakers are as of the date of the recording and are subject to change. These views are not intended as an offer or solicitation with respect to purchase of any security or asset class and they should not be relied on as financial or investment advice. Any investment strategy involves the risk of loss of capital. Past performance does not guarantee future results. It should not be assumed that Morton will make investment recommendations in the future that are consistent with the views expressed herein.
Some of the private investment strategies discussed are available only to eligible clients and involve a high degree of risk.
Data presented in the growth of $1is hypothetical and assumes reinvestment of income and no transaction costs ortaxes. Indices are not available for direct investment; therefore, theirperformance does not reflect the expenses associated with the management of anactual portfolio. The returns of indices presented herein are hypothetical anddo not represent returns that any investor actually attained.
Information relating tothe past performance of large cap stocks, small cap stocks, and small valuestocks, is based on research provided by Dimensional Fund Advisors. Their indicesare defined below:
U.S Large Co Stocks:
S&P 500 Index
The S&P 500 Index is widely regarded as the bestsingle gauge of the U.S. equities market. The index includes a representativesample of 500 leading companies in leading industries of the U.S. economy. The S&P500 Index focuses on the large-cap segment of the market; however, since itincludes a significant portion of the total value of the market, it alsorepresents the market.
Dimensional US Small Cap Index:
Market-Capitalization weighted index of securities of thesmallest US companies whose market capitalization falls in the lowest 8% of thetotal market capitalization of the eligible market. The eligible market iscomposed of securities of US companies traded on the NYSE, NYSE MKT (formerlyAMEX) and Nasdaq Global Market excluding non-US companies, REITs, UITs, and investmentcompanies. After January 1975, the index also excludes companies with thelowest profitability and highest relative price within the small cap universe,as well as those companies with the highest asset growth with the small capuniverse.
Dimensional US Small Cap Value Index
The index composition is a subset of the US Small CapIndex. The subset is defined as companies whose relative price is in the bottom35% (prior to January 1975 - bottom 25%) of the US Small Cap Index after theexclusion of utilities, companies lacking financial data, and companies withnegative relative price. The eligible market is composed of securities of UScompanies traded on the NYSE, NYSE MKT (formerly AMEX), and Nasdaq GlobalMarket, excluding non-US companies, REITs, UITs, investment companies. AfterJanuary 1975, the index also excludes companies with the lowest profitabilitywithin the small cap value universe, as well as those companies with thehighest asset growth with the small cap universe.
Dimensional US Small Cap Growth Index
Consists of companies with market capitalizations in the lowest 8% of the total market capitalization of the eligible market whose relative price is in the top 50% of all small cap companies after the exclusion of utilities, companies lacking financial data, and companies with negative relative price. The index excludes companies with the lowest profitability within the small cap growth universe. The index also excludes those companies with the highest asset growth with the small cap universe. The eligible market is composed of securities of US companies traded on the NYSE, NYSE MKT(formerly AMEX), and Nasdaq Global Market, excluding non-US companies, REITs, UITs, and investment companies.
