The S&P 500 has been on something of a tear. Total returns so far this year (as of Dec. 23), have been 26 per cent. That’s on top of total returns of 26 per cent in 2023.
This is the kind of investment performance that can make some investors wonder whether Warren Buffet was right when he suggested that, for most people, the best thing to do is own the S&P 500 index.
Whether this is the right investment strategy for an investor is something they would need to decide. This is in no way meant to challenge Buffet’s investment perspective. Or, for that matter, to suggest an alternative strategy for individual investors.
But recency bias can be powerful. So, with the S&P 500 up as much as it has been over the past few years, it is a good time to recall why a strategy that involves only investing in that index would require real patience and conviction at times, and why many investors stick with much more diversified strategies.
The S&P 500 has been a great long-term investment: $1,000 invested there 50 years ago would be worth approximately $360,000 today. That beats a 60/40 portfolio made up of the S&P 500 and 10-year U.S. Treasury bonds, which would have only grown to approximately $136,000 over that same period. And it beats an investment in other developed markets, such as the MSCI EAFE (Europe, Australasia and the Far East), which would have only grown to approximately $60,000.
However, a lot can get lost in long-term performance numbers, specifically the episodic and very large drawdowns the S&P 500 has experienced, and its underperformance relative to more balanced portfolios and other markets over a number of multi-year periods.
For example, investors who had 100 per cent of their portfolio invested in the S&P 500 in September 2000 would have lost 45 per cent over the following two years, about twice that of an investor in a 60/40 portfolio. It would have then taken the 100 per cent S&P 500 investor more than six years to recover their losses and almost 20 years to catch up to the 60/40 investor.
This was not the only period of S&P 500 underperformance relative to a 60/40 portfolio: In the late 1970s, it had more than three years of worse performance; in the early 1980s, it had about six years of worse performance; and in the late 1980s, it had more than seven years of worse performance.
Today, investing in the market cap (as opposed to equal weighted) version of the S&P 500 index involves a big bet on the continued strong performance of a small number of companies. The last time the Top 10 companies in the S&P 500 represented as large a percentage of the index as they do today (36 per cent) was in 1964. None of the Top 10 companies in 1964 are in the Top 10 today. In fact, three went bankrupt (General Motors Co., Sears Holdings Corp. and Eastman Kodak Co.) and two merged into other companies (Gulf Oil Corp. and Texaco Inc).