How To Manage Personal Finances Book: Chapter 11- Bank Drive Thru Windows and Common Stock Returns
Author’s Note:
I am posting a text version of this entire book on Substack, and video versions on YouTube. Email ken@stltest.net for details on my 5th book’s publishing date in late ’24 or early ’25.
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Wait- they closed the drive-thru window?
I had to deposit a check, so I drove by a Bank of America branch. I rarely if ever get client checks, and I hadn’t visited a bank in over a year.
I waited in line while one person got 7 different rolls of coins, and a second person tried to deposit a 5-year-old third-party check. OK- I made up the part about the check, but I waited nearly 10 minutes.
The point? I had expectations.
The same is true of most investor’s beliefs about the returns they can earn on stock.
Three types of returns
Generally speaking, there are three ways to earn a return on a stock:
Price appreciation: You profit from selling the stock for more than the cost
Cash dividend: The company pays you a cash dividend, which is a share of company earnings
Stock dividend: You receive a dividend in the form of additional stock, and you can benefit from price appreciation and/or a cash dividend on the new shares
To profit from the stock market over time, you must do something completely counterintuitive.
When you sense danger, don’t run
The U.S. stock market has been an effective tool for investors to generate profits for decades- if you’re willing to be patient and accept volatility.
Notice how I added that “disclaimer” about patience and volatility? When it comes to investing, most people aren’t willing to accept these two realities.
Dire Straits had a big hit with a song called: “Money For Nothing” in the 80s- and investing in the stock market is not a money-for-nothing proposition. If you’re willing to live with the short-term risk and volatility, the stock market can generate earnings over the long term.
How long is long term?
Long term is from 1928 until today.
One tool to measure how the stock market has performed is the Standard and Poor’s 500 index (S&P 500). This is an index of 500 frequently traded stocks in the US markets. The S&P 500 index includes many names you’re heard of- think Microsoft and Proctor & Gamble- recognizable names.
The idea here is that the S&P 500 index behaves in a way that reflects the market as a whole. It’s an indicator of where all stocks may be headed.
So how has this index performed over time? Seeking Alpha provides a great list that shows the S&P 500’s total return from 1928 to 2015. Total return assumes that capital gains (selling the stock for a gain) and dividends earned are reinvested.
As the writer points out: “Over 88 years, the S&P 500 went up 64 years and went down 24 years…. The worst return was -43.84% in 1931. The best return was 52.56% in 1954.”
Now, that may strike you as encouraging or terrifying. I get it.
Rather than looking at year-to-year, consider the average return over time.
Investopedia explains that “The average annualized return since its (S&P 500’s) inception in 1928 through Dec. 31, 2023, is 9.90%. The average annualized return since adopting 500 stocks into the index in 1957 through Dec. 31, 2023, is 10.26%.”
The Lesson
Be a realist- don’t expect more than the S&P 500 average return over time. The ups and downs from one year to the next can be jarring- but stay focused on the average return over 10 years, 20 years- whatever your investing time horizon is.
Past performance is no guarantee of future returns. Discuss risks and returns with an investment advisor.