Investing at a Market Peak

 Investing at a Market Peak

“Buy low, sell high.”

That’s the well-known, traditional advice about the stock market.

But consider this advice from the legendary investor Warren Buffett: “If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.”

If you’re like me, you have terrible luck. What if you buy high? Well…you could take Buffett’s advice, hanging on instead of selling.

If you do that, how has that strategy fared in the past?

I have data going back to 1928, so I investigated. And here’s what I found.

For your information, here are the specifics of what I’m looking at:

• S&P 500, 1928 through 2019

  • technically, the S&P 500 didn’t exist in 1928. But inclusion in the S&P 500 is based on rules, so researchers have gone back and applied those rules to the companies that were available in 1928.

  • That’s the information I have. Don’t like it? Go get your own data…

• Dividends reinvested

• No adjustment for inflation

• No fees deducted

• $100 initial investment, no other contributions or withdrawals

Ready to see what happened? Here we go:

I picked out seven of the worst-performing stretches in that timeframe, using periods of 17 years.

Why 17?

Good question.

The long answer is that I was going through the data, cherry picking the worst possible periods, but I wanted to get a long enough timeframe to capture a variety of different stretches—good times, bad times, mediocre times. And a couple of those stretches ended up being 17 years, so thereafter, I used 17 years for consistency.

Remember, the point of this exercise is to determine what would have happened to buy-and-hold investors in the S&P 500 over a fairly long period of time. So my methodology is consistent with the goal of this entire analysis.

If that explanation was too nerdy for you, let’s just leave it at, “I’m weird.”

And, as always, feel free to find some historical data and run your own analysis. Then you can use whatever settings you want!

1. So, what’s the worst possible period in our analysis? As you might expect, it begins in 1928 and runs through 1944.

Yep, a pretty lousy period. And the initial $100 investment in 1928 would have been worth, by the end of 1944 (drumroll, please)...over $189!

Not exactly a marvelous return. But it’s a sizable gain nonetheless. In fact, a buy-and-hold investor would have nearly doubled his money during that 17-year period—a period that encompasses the Great Depression and ends while World War II is still raging!

And let’s recall that, in this example, we invested at the peak of the pre-Depression stock market, and held those stocks through the entirety of the Great Depression, and most of WWII.

To be a buy-and-hold investor during such a period, you’d have to be an incurable optimist!

Take a moment to put yourself in the shoes of somebody who was alive in 1944. With 15 miserable years behind you, what do you really think the world would look like in 1950? Would you have any clue when the war would end? Or what would happen after that?

How could war-ravaged Europe possibly recover? How could Asian countries rebuild, especially after centuries of bad blood culminated in well over a decade of savage war crimes? Surely, the world will plunge right back into another depression, right?

Somebody in 1944 would have been very justified in a pervasive sense of pessimism about the future. But, as it turns out, a half-century of mostly peaceful competition between the United States and the Soviet Union sparked remarkable worldwide economic and technological growth.

There have, of course, been some rough patches. It certainly wasn’t always smooth sailing! But the general trend has been in a positive direction.

Don’t believe me? Let’s do a thought experiment: suppose you time-traveled back to 1944 and described the world in 2021. They’d be certain you were making up absurd fantasies!

“You’re telling me that 25 years from now, human beings will walk on the moon?!

“And that, by 2020, it’s commonplace for people to use personal computing machines to play a motion picture of their choice, at any time of day or night?

“Not only that, but people buy an electronic rectangle that’ll fit in one hand—and use it to take and store photographs, play music, look up information like an encyclopedia, and instantly communicate with people by voice or written word?!

“That’s pretty good stuff; you should send these stories to science fiction magazines for kids. Assuming the editors don’t think it’s all too ridiculous to print!”

But, of course, we don’t ever really think about it, because these things are part of everyday life.

Also consider the cost of common items. In 1940, a typical home cost less than $3000. Imagine telling a citizen of 1944 that, in March 2021, the average price of a new car tops $40,000!

In fact, I’ll do something similar to you right now: assuming that pace continues over the next century, the typical family in the year 2102 will spend a mind-boggling $540,000 for a new vehicle!

I’ll end this digression with some perspective: the 17 years ending in December of 1944 was, by and large, a pretty miserable period. And a long-term, buy-and-hold investor still made money!

If you’re curious, the gain—from $100 to $189.44 over 17 years—works out to an annualized return of 3.83%. A very modest return, to be sure. But still positive!

Remember that this is a bad-luck investor with terrible timing. Suppose he hadn’t bought stocks in 1928. He invested his $100 in January of 1932 instead. This investor would instead have ended 1944 with $338.24, for an annualized rate of return of 9.83% over this 13-year stretch.

And that’s why they tell you to buy low.

2. Moving on to the next terrible period, we’re investing $100 in the S&P 500 at the beginning of 1965. Our 17-year period therefore ends at the end of 1981.

What happened during this period? Vietnam and stagflation come to mind. So does Watergate, and the end of the gold standard for the U.S. dollar. I also think of the Iranian hostage crisis and the oil shock of 1973.

Another period of turmoil and lousy stock performance. How much was our $100 investment worth by the end of this period?

$283.54.

Thanks to the rapid inflation of the 1970s, this $283 was worth quite a bit less than it would have been in 1965. But still, the annualized return of 6.32% over this period isn’t too terrible.

Not enough to keep pace with the rampant inflation of the time (which is why 1965 was a terrible year to retire!), but better than keeping that money in the bank! Bonds performed similarly over that time period, and real estate returned about 7.25%.

The only asset class that exceeded the pace of inflation was gold—and during normal times, gold is actually a pretty rotten investment.

In inflation-adjusted terms, this would have been the worst 17-year investment period since 1928. A buy-and-hold S&P 500 investor would have made money from 1965 to 1981, but lost purchasing power.

Unless, of course, he continued to hold through the rest of the 1980s.

3. The next worst 17-year period I found was from 1992 through 2008, with a slightly better average rate of return: 6.74%. During this period, $100 would have turned into $303.

Unlike the 1970s, though, the U.S. did not suffer high inflation during this period, so the ‘real’ inflation-adjusted return was actually positive.

Obviously, I selected this period by starting with the atrocious returns of 2008 and working backwards. If I stop in 2007 instead, we have a 16-year period with a much rosier annualized return of 10.3%. The initial $100 investment in 1992 would have been worth $481.10 by the end of 2007, before plunging to the aforementioned $303.

Extending the period to include the rebound of 2009 would yield an annualized return of 7.75% over 18 years, with $100 growing to $383.41.

Yep, cherry-picking works both ways.

4. I’m not going to go through all seven periods here, mostly because I’ll bore you. But I will highlight one more period, starting in 1986 and ending in 2002.

Once again, I picked this ending date on purpose, primarily because the ‘dot-com bomb’ yielded 3 consecutive losing years: 2000, 2001, and 2002. Let me reiterate: I picked this because I was looking for the worst 17-year periods.

During this timeframe, a $100 investment would have turned into $636.83. That’s an annual rate of return of 11.51%.

It includes Black Monday in October 1987—still the largest single-day percentage drop in the history of the U.S. stock market—and ends with the infamous dot-com bomb!

I was looking for bad historical timeframes, and there was still enough growth during the ‘up’ years that the average return exceeded 11%!

Conclusion

After carefully reading over this exercise, I hope you’ve reached a similar conclusion to mine.

For comparison’s sake, here’s my conclusion: the stock market is an extremely powerful wealth-building tool over the long run. It’s certainly not a surefire road to wealth (see: the 1970s), but ignore the market at your own peril.

History suggests that you should take advantage of the opportunity to invest in low-cost, broad-based index funds. But history also contains enough lessons that you should hedge your bet with other assets, such as bonds, real estate, and maybe even a little bit of gold.

My own investments are broadly diversified, with a worldwide portfolio of stocks, bonds, and real estate. I’d counsel a similar approach for anyone else who cares to listen. Nonetheless, stocks will continue to anchor my portfolio for decades to come.

And history suggests that’s a winning bet.