What is the S&P 500?

What did the market do today? Was it up? Down? When people refer to the “the market” it’s usually the S&P 500® Index. But what is it? It’s a key benchmark money managers, mutual funds, and other professionals use to measure performance.

The S&P 500® Index is a collection of the 500 largest publicly traded U.S. corporations. It’s a market weighted index meaning the largest companies have the greatest impact on performance – good and bad.  The largest company in the index is Microsoft; the smallest is News Corp. When Microsoft moves, so will the index. The 10 largest companies in the index are Microsoft, Apple, Amazon, Berkshire Hathaway, Facebook, Johnson & Johnson, JP Morgan Chase, Alphabet, Exxon Mobil, and Bank of America. The largest sectors are Information Technology, Healthcare and Financials.

Standard & Poor’s launched the now famous index on March 4, 1957. It’s a better gauge of the market because of the breadth of its holdings especially when compared to the Dow Jones Industrial Average which only holds 30 companies.[1] The Dow Jones index was founded in May 1896.

Because of the breadth and consistency over time there are currently $9.9 trillion in assets linked to this index. The most popular one is the Vanguard S&P 500 Index Fund founded by Mr. John Bogle. Mr. Bogle recently passed away and this put a spotlight on this popular category. Mr. Bogle started the fund in 1976 to a less than stellar opening. His goal was to raise $150 million but he only received $11.4 million – a rounding error on Wall Street.[2] The fund currently has assets of $400 billion! If you had invested $10,000 in this fund when it opened, your account balance would be worth $744,951 today. It has generated an average annual return of 10.71% since its feeble beginning.

Wall Street was not a fan of Mr. Bogle’s fund because of its low fee structure and average returns. What investor would want to own a fund generating average returns when active fund managers and stock pickers could do so much better? Makes sense. However, active stock pickers rarely outperform the S&P 500® Index. In fact, 91% of active fund managers failed to outperform the S&P 500® over a 10-year period and 95% of funds with high fees lagged this key benchmark. The active managers were below average, well below.[3]

Rather than average returns consider market returns. If you can generate market returns over time, your wealth should grow despite the occasional drop in value or spike in volatility. A low cost, diversified investment like the Vanguard S&P 500® Index Fund is a great candidate for most investors.

As a side note, the S&P 500 owns 505 companies!

Happy Investing.

“The two greatest enemies of the equity fund investor are expenses and emotions.” ~ John C. Bogle

February 1, 2019

Bill Parrott is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog.

 

 

 

[1] file:///C:/Users/Bill%20Parrott/Downloads/fs-sp-500.pdf

[2] https://www.inc.com/magazine/201210/eric-schurenberg/how-i-did-it-john-bogle-the-vanguard-group.html, B Eric Schurenberg, 9/25/2012

[3] https://office.morningstar.com/research/doc/Aug%2023%202018_Active_vs_Passively_Managed_Funds_Takeaways_from_Our_Mid-Year_Report__880196, Ben Johnson, August 23, 2018

What is Average?

At lunch a few weeks ago, a friend of mine said he didn’t want his son to be average. I was struck by his comment because all his kids do well in school and they’re exceptional athletes. I then spent some time pondering the word – average. What is average? According to Merriam-Webster it means a single value that summarizes or represents the general significance of a set of unequal values. It also states a level, typical of a group, class, or series.

Do you know Akani Simbine? He is an Olympic sprinter from South Africa who finished 5th in the men’s 100-meter dash at the 2016 Olympics. His time was 9.94 seconds – the average winning time of the eight runners in the race.  By Olympic standards, he’s an average sprinter. However, if he raced anybody else in the world, he’d win – by a lot. Is Mr. Simbine average?

The average score for the top 20 finishers at the 2018 Masters was 281. Tony Finau finished 10th with a score of 281. Is Mr. Finau an average golfer? If he was in your foursome at your local muni course, do you think he’d win? I do.

The average height of an NBA player is 6 foot 7. Russell Westbrook is only 6 foot 3. He has below average height, but if he showed up at your local YMCA to play basketball, he’d dominate the court. Would you be able to guard Mr. Westbrook one on one? Doubtful.

Average is relative. Metrics and benchmarks matter.

Some investors shun index funds because they’re designed to generate market returns, or average returns. Who wants average returns? If you were able to capture these returns, your account balance would grow substantially. Yet, most investors fail to do so and, as a result, produce below average returns.

According to a 2017 Dalbar study, investors underperformed the S&P 500 by a wide margin. The S&P 500 is an unmanaged index of stocks. At the time of their report the index returned 11.96%, the individual investor made 7.26%, a difference of 4.7%. The 20-year annualized return for the index was 7.68%, the individual made 4.79%.[1]

The dollar differential is staggering. A $100,000 investment for twenty years earning 7.68% will grow to $439,239. If the rate drops to 4.79%, the balance falls to $254,915, a difference of 42%.

Why do individual investors constantly underperform the market? Here are a few reasons.

Emotions. Investors fall prey to greed and fear. They buy high and sell low. When stocks rise, investors feel good and they buy more stocks. When stocks fall, investors panic and they sell their holdings. The best time to buy is when everybody else is selling.

No Plan. Investors without a financial plan are likely to react to negative news. They don’t have a game plan. Without a plan, it will be a challenge for investors to have much financial success. An archer needs a target.

Short-term thinking. Markets fluctuate, and no trend lasts forever. Focusing on recent, short-term market moves may cause investors to lose sight of their long-term goals. Marathon runners don’t panic at the five-mile mark.

Noise. TV shows, newspaper headlines, Facebook posts, and tweets will try to knock you off your target.  Distracted investors make mistakes. Focus on your goals and tune out the noise.

Lack of accountability. A trusted advisor can help you navigate troubled waters. A Certified Financial Planner™ can design a plan and portfolio fit for you and your family.

Buy and hold investors can capture average market returns if they have the courage to stay the course. Focusing on your goals and following your plan will pay substantial dividends. Average returns may deliver above average wealth.

I feel like a fugitive from the law of averages. ~ William H. Mauldin

December 10, 2018

Bill Parrott is the President and CEO of Parrott Wealth Management firm located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process to help our clients pursue a life of purpose.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog.

 

 

 

 

 

 

 

[1] https://www.marketwatch.com/story/americans-are-still-terrible-at-investing-annual-study-once-again-shows-2017-10-19, Lance Roberts, 10/21/2017

A Recovering Stock Picker.

The siren of individual stocks has drawn me in for decades ever since I entered the brokerage business some thirty years ago.  I had visions of becoming the next Warren Buffett, Peter Lynch or Jesse Livermore.

I’ve read numerous books on investing, charting and trading.  The information has been priceless. I also garnered a tremendous amount of investment knowledge by talking to clients about their stock positions.

In the early ‘90s, I answered incoming calls for clients of my firm’s office who wanted stock quotes.  I shared a Bunker-Ramo terminal with another broker and I was limited to 12 stock symbols on my side of the monitor.  Giving quotes was a tedious affair especially if a client had a large portfolio.  If he wanted more information, he’d have to wait until the following day to read the newspaper or review his month end brokerage statement.

Pre-internet, information available on common stocks was dominated by a handful of big brokerage firms such as Merrill Lynch, Smith Barney, Paine Weber and Dean Witter.  Their voluminous research reports were coveted by individual investors.  These firms controlled the information and, therefore, held most of the power to move a stock.

Today almost anybody can move a stock’s price as we recently witnessed by Kylie Jenner’s tweet about Snap Chat.  Its market capitalization dropped by $1.3 billion because of her tweet.[1]

The internet is the ultimate equalizer.  Investors can receive real time quotes delivered via several devices.  It’s impossible to act on company news because of how fast information travels.  In addition, Regulation Fair Disclosure (Reg FD) was initiated by The Securities and Exchange Commission.  They ruled that all publicly traded companies must release material information to all investors at the same time.[2]  The playing field for all investors has been leveled.

The buy and hold strategy for stock owners appears to be fading as investors look to capitalize on news delivered through CNBC, Twitter and other media outlets.  Investors trade by stock symbol not knowing, or caring, what a company does.  For example, Herzfeld Caribbean Basin Fund Inc, ticker symbol CUBA stock price rose sharply after the death of Fidel Castro despite having no connection to Castro or the country.  It appears the only reason investors bid up the price of this fund was because of the ticker symbol.[3]

The past few years I’ve been converting individual stocks to low-cost index funds and exchange traded funds.  The reduction in costs and reach of these funds is too compelling to ignore.  Furthermore, a portfolio of five or six funds will give me instant access to thousands of companies from around the world.

The data also supports a move to index funds away from stock picking and actively traded mutual funds.  In a recent S&P SPIVA® study they found that over a 15-year period 93% of large-cap money managers failed to beat their benchmark.  These results are similar for small, mid and international money managers.[4]  This underperformance also occurs on a 1, 3, 5 and 10-year basis.

The Vanguard S&P 500 Index fund has generated a ten-year average annual return of 9.64%. However, investors in the fund only made 5.38% per year because they traded in and out of the fund.[5]  If they had held on they would’ve more than doubled their money.  A buy and hold strategy is difficult to beat.

Warren Buffett, the definitive stock picker, recently won a bet against hedge fund manager Protégé Partners.  He bet them that the passive S&P 500 Index would outperform a basket of five actively managed hedge funds over a ten-year period. How did it turn out?  The S&P 500 trounced the hedge funds by 89%!  The S&P 500 returned 125%; the hedge funds, 36%.[6]

It’s been hard to wean myself off stocks and move the money to a diversified portfolio of index funds, but it’s been for the better.  I’ve been able to spend more time helping clients crystallize their goals through financial planning since I’m no longer tethered to a monitor watching stocks rise and fall.  A similar move may benefit you, especially if you’re looking for financial peace and freedom.

An intelligent heart acquires knowledge, and the ear of the wise seeks knowledge. ~ Proverbs 18:15.

Bill Parrott is the President and CEO of Parrott Wealth Management an independent, fee-only, fiduciary financial planning and investment management firm in Austin, TX.  For more information please visit www.parrottwealth.com.

2/26/2018

Note:  Past performance is not a guarantee of future returns.  Your returns may differ than those posted in this blog and investments aren’t guaranteed.

 

http://www.foxnews.com/opinion/2018/02/24/kylie-jenner-breaks-up-with-snapchat-and-1-3-billion-loss-in-stock-value-is-lesson-for-other-companies.html, by Karol Markowicz, 2/24/2018

[2] https://www.sec.gov/fast-answers/answers-regfdhtm.html

[3] https://www.marketwatch.com/story/mutual-fund-with-cuba-ticker-soars-after-fidel-castros-death-2016-11-28, Tomi Kilgore, 11/28/2016

[4] https://us.spindices.com/documents/spiva/spiva-us-mid-year-2017.pdf, Aye M. Soe, CFA Managing Director Global Research & Design and Ryan Poirier, FRM Senior Analyst Global Research & Design, report accessed 2/26/2018.

[5] Morningstar Office Hypothetical Tool, Fund symbol VFINX, 1/01/2008 to 01/31/2018.

[6] http://money.cnn.com/2018/02/24/investing/warren-buffett-annual-letter-hedge-fund-bet/index.html, by Jackie Wattles, 2/24/2018.

Stock Picking v. Indexing.

Individual stock picking is exciting and the thrill of selecting a winning stock is exhilarating.  Investors are constantly searching for the next big winner hoping to find another Amazon.  Stock pickers try to outperform the market, usually the S&P 500, by buying winners and ignoring losers.  The top ten stocks in the S&P 500 this year are up 67% while the bottom ten are down 41%.  How do you find the best stocks?

I’ve found most investors primarily focus on large companies with brand name appeal like Apple, McDonalds and Boeing and ignore other sectors such as small companies or international investments.  Investors also tend to overload on stocks in their own backyard so individuals who live in Houston are likely to own shares in Exxon.

Trying to pick stocks to outperform the S&P 500 Index is futile because in a diversified portfolio you may only have 25% exposure to companies in the S&P 500.  In a million-dollar account with 60% invested in stocks and 40% in bonds, the large cap holdings will account for 25% of the entire portfolio.  With $250,000 to invest you can allocate $25,000 to ten stocks.   Morningstar currently tracks over 20,000 companies so how do you pick the ten best?  If you limit your search to the S&P 500, you’d have to identify the top 2% of this index to find your ten stocks.

To create more diversification in your portfolio, you need to add more stocks.  As you add more stocks, your account starts to resemble an index fund.  A study by Dimensional Fund Advisors found that if you own 50 stocks, your probability of outperforming the stock market on a one-year basis is 56%.   Over a ten-year period, the probability of outperforming the market is 69%.   How many stocks do you need to own to get close to outperforming the market?  The answer is 1,000![1]

Most investors don’t have the financial resources to own 1,000 stocks nor do they have the time to follow and research each individual company.   Jim Cramer says you need to dedicate an hour each week to each position to fully grasp the stocks you own.[2]   If you own 1,000 companies, you need to allocate 1,000 hours to study your holdings and a week only has 168 hours so you can do the math.

A better alternative for your investment portfolio, is to purchase a basket of index funds based on your financial goals.  Your financial goals will help determine your asset allocation and investment selection.   Instead of spending thousands of hours on stock research, devote your time and effort to refining your goals.

Teach us to number our days, that we may gain a heart of wisdom. ~ Psalm 90:12.

Bill Parrott is the President and CEO of Parrott Wealth Management, LLC.  If you want more information on financial planning and investment management, please visit www.parrottwealth.com.

August 19, 2017

 

[1] Dimensional Fund Advisors, The Importance of Diversification, June 1979 to June 2016.

[2] https://www.thestreet.com/static/rules6.html