NWP Monthly Digest | August 2024
I have a secret for you. Successful investing doesn’t require you to beat the stock market.
Does that make sense? When we invest money for our clients, the goal is NEVER to simply beat the market. I’m sure that may sound counterintuitive to most, but it’s an endeavor that is nearly impossible. More importantly, it’s not necessary.
The stock market will provide you with a certain amount of return (especially over long periods of time), and the goal is to capture that return in the most efficient way possible. One of my favorite sports colloquialisms is “calm down and let the game come to you.” Perhaps you’ve heard that before, but that’s the best way I know of to achieve investment success. Know your time frame, understand the known risks, and avoid trying to do too much.
Watching the Olympic gymnasts this week, I heard the commentators discussing the Italian coaches. Paraphrasing, of course, the Italians said that trying to win a medal was a recipe for failure. Oftentimes, knowing the math on what scores you need to get you to the podium creates a sense of urgency to try too hard, which causes the athletes to underperform what they might otherwise be capable of. “Trying too hard to win a medal has created more 4th and 5th place finishes than we can count.”
I love that. As some of you may know, I coach high school baseball on the side here in the Denver area. I constantly tell the players that you will never get better at baseball by trying harder. You have to try easier. It’s a phrase I stole from former Colorado Rockies first baseman, and now Hall-of-Famer, Todd Helton. Grip the ball too tight, and you will throw the ball with less velocity. Grip the bat too tight, and you won’t hit the ball out of the infield. The best baseball players have a very slow heartbeat and they never, ever try too hard.
Listen, there are a lot of things that our world allows us to excel at by trying harder. Getting in one more rep at the gym. Working longer hours. Hustle culture bros and all that…All of those things might work some of the time. I love hard work and hard workers, but it doesn’t always translate to success. Investing in the stock market is one of those areas where less produces more.
There has been a lot of really cool research discussed this summer on stock market returns from some of the smartest people in the financial world. I’m going to breakdown a few of those here.
THE BEST PERFORMING STOCK IN HISTORY
Do you know what it is? The best performing stock EVER? Take a few guesses…
For what it’s worth, my guess was Microsoft. I was wrong.
It’s Altria (ticker: MO), formerly known as Philip Morris. Yep. Tabacco.
Since 1926, Altria is up ~265 million percent, and I’m not doing a Dr. Evil impression. Seriously, it’s up 265,528,901% to be exact. I think a lot of us would assume that the best performing stock of all time would average about 30% or more per year in gains, but Altria’s gaudy number actually works out to about 16.3% per year. Compound interest is so incredibly powerful.
Back in 1926, had you invested your family’s life savings of $1,000 (which was a lot of money back then) in Philip Morris/Altria stock, it would be worth over $2.5 billion today.
Another shocking thing from the different side of the lens is that 16.3% per year is a really good number, but it’s not as crazy high as I would have guessed. By comparison, Nvidia had the highest annual return of any stock that has been in existence for at least 20 years, and that was 33.4%, but to do that for almost 100 years is a different story altogether.
Of the top 100 performing stocks of all-time, only six have average annual returns above 20%, and none of the top 20.
All of this data was produced by Hendrik Bessembinder of Arizona State University’s Carey School of Business. He looked at the returns of every stock since 1926, and it’s absolutely fascinating.
Maybe the most fascinating thing, however, is….
MOST STOCKS PERFORM REALLY POORLY
What’s that, Jeff? Seems like a weird thing to point out when I’m so positive that investing in the stock market is a good thing. But, in fact, more than half of all the stocks in history (4 out of 7) have produced returns less than the risk-free rate (using US T-Bills as our proxy).
Only 38 of the nearly 30,000 stocks have been around for the entire history of the study. Staying in business is hard.
We’re going to get a little nerdy here, so stay with me. You know the difference between MEAN and MEDIAN, right? The mean being the average return of all the stocks, and the median being the mid-point, where half have a better return and half have a worse return.
So, if we look at the median for the roughly 30,000 stocks that Bessembinder used in his study, we will see that the median return is -7.41%. Half of all of the stocks in history produced a negative cumulative return since 1926.
But the mean (average) return is +22,830%. When you invest in the stock market, there are A LOT of losers. But those winners, man…
Getting even more granular, ~100% of that wealth generated by investing in stocks came from only 4% of the companies since the beginning of the study. That number is insane. The other 96% of the stocks provided nothing.
Since crystal balls are in short supply, I think trying to figure out which companies are going to generate the majority of the return for the next 20 to 30 years seems like a crazy gamble to make. Especially when you factor in that the S&P 500 index produced returns of 10.3% per year going back to 1926.
As I discussed in my last newsletter in June, diversification is a great way to reduce risk in your portfolio. Better yet, however, is that diversification (in the form of using an index) makes it so you don’t have to pick every winning stock correctly. Own them all and let the winners carry the water.
As always, the two most important decisions you need to make in developing your investment strategy are understanding 1) How long your time frame is and 2) How should your money be divided between stocks, bonds, cash, and alternatives (your asset allocation).
SOURCE: Do stocks outperform Treasury bills? - Hendrik Bessembinder, WP Carey School of Busines, Arizona State University
UNDERSTANDING REAL RETURNS
This is a big one that I think falls through the cracks a lot. The most fundamental reason we save money is to create future income opportunities to pay for things like college, retirement, vacations, etc. And the most important reason we invest those savings is to keep up with inflation.
Real returns are simply the overall gross return you get from your investments minus inflation. That’s why using cash in the form of savings accounts or putting money under your mattress is so bad for your future purchasing power.
Inflation has been the headline story in the world of finance for the last two years, and it’s all anybody can talk about. Historically, and depending on which measure of inflation you use, inflation has averaged somewhere between 2 and 3.5% per year. But there are obviously periods where it is extremely high (June of 2022 was when our most recent bout of inflation peaked at 9.1% year-over-year) and periods where it is much lower. The Fed’s target inflation is 2%, for what it’s worth.
It’s more interesting to look at inflation over different periods. The 1970s, for example, had average annual inflation of nearly 6%. The 2010s, by contrast, averaged below 2% per year.
Stocks are still the best and most reliable way to hedge against inflation. As of this summer, average real returns for the stock market are sitting at 7.5% for the last 20 years. That’s pretty consistent with the long-term average. For the period from 1960 to 1982, however, the average real return was only 1.4% above inflation, the lowest in modern times.
Investment planning would be much easier if you were promised a specific rate of return but financial markets don’t work like that.
You have to make reasonable decisions in the present about an unknowable future and be flexible enough to adapt when things don’t go as planned.
That’s not the precise answer most people would like to hear but financial planning does not come with 100% precision. ~Ben Carlson, Ritholtz Wealth Management
For me, personally, I think getting 5-6% real returns over a long period should be more than acceptable, but we will never know when and where inflation will rear its ugly head. Even in the worst period that I mentioned earlier, at least investing in stocks protected your purchasing power.
Where I’m going with all this is that investing in stocks is something that most investors are going to have to make peace with. It’s not easy, and there will always be periods where you are frustrated or downright sick to your stomach. But if you have a plan and you stick to it, the results will speak for themselves. Don’t try too hard and feel like you must constantly make changes looking for the next great thing.
It's not “don’t just stand there! Do SOMETHING!”
As Jack Bogle, Vanguard founder and investing legend, liked to say, “don’t just do something! Stand there!”
Noble Wealth Pro Tip of the Month
One thing that I have fielded a lot of client calls about lately is the incredibly high cost of very basic property and casualty insurance (your homeowner’s and auto insurance, to be more specific). If you haven’t noticed or looked at your statements lately, maybe you should.
For me personally, my homeowner’s premium has increased by almost 100% in the last few years, and that’s without making any claims. I have five drivers in my household, so our auto insurance is in another stratosphere, but you should check that, too.
Two of the highest price increases in the recent inflation reports are very specific to auto and homeowner’s insurance. They are increasing at a much faster rate than almost anything else. Depending on what state you live in, there are chances that carriers are pulling out of your market completely.
Insurance can be a difficult thing to negotiate (especially because you legally have to carry auto insurance and homeowner’s insurance if you have a mortgage) and usually not something that there is an easy solution for. In the case of your P&C coverage, you really only have a few options:
Go to your agent and ask them if they can do anything for you
Bundle your policies together
Increase your deductibles (be very careful that you can handle that increase)
Shop your policies around to all of the carriers
You also get a two-for-one this month on tips. The other one is in regards to inherited IRAs and the new 10-year rule for withdrawals. Since the passing of Secure Act 2.0, one very glaring omission has been the IRS and how they were going to rule on required minimum distributions (RMDs) for non-spousal recipients.
A couple of basic facts here need to be addressed first. In the past, if you inherited an IRA from a relative that was not your spouse, you could elect to take a lump sum distribution of that IRA (paying ordinary income tax on that amount) or you could select the “stretch” option, which allowed you to take minimum distributions from the account based on your life expectancy.
That changed with Secure ACT 2.0. Out with the “stretch” option, and in with the 10-year rule. What we already knew is that you could still take a lump sum, but now you would have to deplete the IRA within a 10-year window. What we didn’t know is if you had to take RMDs from the IRA each year of the 10-year window or if you could wait until the 364th day of the 10th year.
Well, the IRS finally ruled on that in July. You can read more about it here or reach out to us to discuss. The bottom line is that for many people with a non-spousal, inherited IRA, you WILL have to start taking RMDs starting next year in 2025.
Things We’re Reading and Enjoying
The Story that Changes the World, by Tom Morgan
I’ll just go with the standard “trust me and read this one”. It’s not specific to personal finance, but more about how our world is being is being fractured by social media and the competition for our attention. Our brain’s left hemisphere (narrowly focused, logical, and linear) is competing with the right hemisphere (emotional, intuitive, need for relationships) for our focus. A brighter future requires the two halves of our brain to work in tandem.
The nature of the left hemisphere is best described in one word: “disconnected”. With its very narrow focus, the left hemisphere deals in conceptual thought. It is highly verbal and abstracted from the world around us. As a result, we have created disconnected digital worlds, in the metaverse, social media, and video games. This draws us even further into our heads, away from our environment, our bodies, and each other.
Other articles that helped inspire this month’s newsletter…
What is the Best Performing Stock of All Time? - by Meb Faber
The Biggest Winners in the Stock Market - by Ben Carlson
What’s the Worst Long-Term Return for US Stocks? - by Ben Carlson
“There is nothing noble about being superior to your fellow man. True nobility is being superior to your former self.” - Ernest Hemingway
