S&P500: An investment worth considering?
For most finance professionals, the S&P500 index is the ultimate opponent to be outperformed, but very few succeed in doing so. With commissions, capital gains taxes, and human emotions playing against you, merely matching the index puts one ahead of most investors. Some investors might manage to beat it in the short run, but they are very likely to eventually fall behind it in terms of returns. In fact, recent statistics suggest that around 92% of U.S. equity large-cap funds are outperformed by the S&P500 within a 15-year window.
A large-cap fund is a type of mutual fund that invests a significant proportion of its assets into companies with a large market capitalization value (over $10 billion), also often referred to as blue chip stocks. These companies are usually well-established firms and leaders within their domain, with stable earnings, transparent reporting, and high dividend payout ratios.
Since 1957 (the year when the number of stocks in the index reached 500), the average annual return of the S&P500 is around 8% per year. This being an average it should be noted that the index fluctuates around this average heavily. There were years where the index jumped over 20%, but also times when it dropped significantly (notably in 2008 reaching a negative 38.49%).
The S&P500 is also a widely endorsed index. On multiple occasions, Berkshire Hathaway’s Warren Buffett publicly stated that he believes the S&P500 is a great tool for diversification and a good instrument for people lacking previous investment experience. Burton G. Malkiel, Princeton economist and author of “A Random Walk Down Wall Street”, argues in his book that stock prices exhibit a “random walk”, thereby positing that stock prices are mostly arbitrary, and that one cannot consistently outperform market average. He also highlights in the first pages of his book that an individual that invested $10,000 in the S&P500 index at the beginning of 1969 would have had a portfolio worth $736,196 by June 2014 (assuming all dividends were reinvested). On the other hand, an investor in an average actively managed fund would have a portfolio worth $501,470 with the same initial investment, a notable difference.
One thing that should be noted here is the 45-year span of the comparison. What is crucial for someone seeking to secure a return on investment is to consider committing to a longer period, where the growth of the stocks would likely be driven by actual growth of the underlying assets. It is of course possible to attempt to time the market, buying low and selling high, but this is not recommendable for most inexperienced investors.
For more information on S&P500 index, how it came to be and why it is relevant, check out our series (part 1 & part 2) on the index.
So, what if you want a piece of the cake too?
For the average or novice investor, it can be very costly to buy or mimic the index independently, as this would entail purchasing the 505 stocks that make it up, whilst paying transaction fees for each purchase. To satisfy the market’s demand for an instrument providing cheap exposure to the S&P500, various asset management firms introduced passively managed ETFs that charge well below the average 0.44% expense ratio. The expense ratio is what you will be charged per year by the firm running the fund.
Out of the many ETFs providing exposure to the S&P500 index, this article will discuss some of the more popular ones to provide an overview of what is out there and what should be considered when investing into them. These ETFs try to replicate the S&P500 by holding shares in roughly equal proportions to the index. They also happen to be the world’s biggest ETFs, with enormously high Assets Under Management (AUM) figures.
Expense ratio: 0.09%
Dividend yield: 1.84%
AUM: $270 Billion
Expense ratio: 0.03%
Dividend yield: 1.94%
AUM: $122 Billion
Expense ratio: 0.04%
Dividend yield: 2.07%
AUM: $189 Billion
With around $270 Billion AUM, SPY ETF is currently the largest one in the world, making it more liquid than its counterparts. This liquidity is useful mostly to investors that want to buy or sell large quantities of the ETF without affecting its price too much. This, however, is unlikely to be something most of you are going to be worried about.
On the other hand, what should be paid attention to are the expense ratios and dividend yields, which influence the returns you receive. Here, the SPY ETF performs most poorly of the three, being over twice as expensive and having a lower dividend yield. I think by now you get the idea: the less expensive, the better, the higher the dividend yield, the better, and the higher the AUM, the easier it is to buy or sell the ETF. This, however, does not mean that it is necessarily going to be more expensive for you to invest in SPY, or that the other ones are going to significantly outperform it. In fact, commissions are going to play a vital role when investing in these ETFs. Brokers will charge differently for you to buy shares of these ETFs, and depending on which you have, you might want to consider different options. For example, Dutch online broker DEGIRO lets you invest commission-free into a wide selection of ETFs once a month, allowing you to build up your portfolio steadily and cheaply. There are many brokers that you could decide to use when starting to invest, but you should be careful not to have commissions erase your hard-earned profits.
In case you are now considering investing in an ETF, the decision may feel a bit overwhelming for you, but there is no need to make a big deal out of it. As can be seen from the graph and table below, the returns from the three ETFs (SPY in blue, VOO in red and IVV in yellow) have only been marginally different since 2011. The variation can be attributed to the different expense ratios but remains insignificant for smaller investments.
Source: portfoliovisualizer.com
SPY=Portfolio 1
VOO=Portfolio 2
IVV=Portfolio 3
Source: investingfacts.com
As great of an investment opportunity as the S&P500 seems to be, it has not left investors unanimous regarding its benefits. One notable figure that recently made his doubts about the massive inflow of cash into index funds in recent years is Michael J. Burry. Rising to fame by predicting the housing market crash 2005 and eventually making over $700 million for his investors off one single trade (or on a single bet as some see it) in 2007. Burry recently stated that he believes we are now in an index bubble, and coming from someone with such a track record, listening might not be a bad idea.
Post Editing by Tom Handels