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OK, here is the explanation. Maybe it isn't as obvious as I thought. Let's say that you invest in 100 random stocks in 1978 and intend to keep them as a long t
by mixmax 18y ago
OK, here is the explanation. Maybe it isn't as obvious as I thought.
Let's say that you invest in 100 random stocks in 1978 and intend to keep them as a long term investment. In 2008 when you want to sell your stock it has on average risen by x%. But some of the companies you invested in have gone bankrupt, and thus these shares are worth nothing. This pulls your entire portfolio down by quite a bit.
Now if you look back from 2008 instead of looking forward from 1978 you will see a different picture. If you pick 100 random stocks and see what their stockprice was in 1978 (which is what this guy seems to have done) you might expect to get the same result, but you don't. A lot of companies have gone bankrupt in those 30 years, and you don't include these in your back-looking portfolio. Yet, as we see these days, it is a real scenario that the company you have invested in will simply tank and your shares will be worth nothing. Over thirty years my guess is that 3 out of 100 companies will go bankrupt, meaning that bankruptcies alone diminishes your portfolios value by 3%.
I think this is quite substabtial.
- mattmaroon 18y agoI still don't understand. He's tracking the S&P 500 which changes over time. Have any companies gone bankrupt from that before being delisted? If so, they'd be factored in already. If not, then someone with SPDRs (had they existed) wouldn't have cared.
- mattmaroon 18y agoAlso bankruptcies count into your average return of x% if you're tracking the market as a whole. 3 companies will go bankrupt (-100%) but 1 that grossly outperforms the market (+1000% in a few years, for example) more than covers it. It's an average, that's what averages do.
- tomsaffell 18y agoThis is an interesting point. The analysis was done on the 'index value' of the S&P 500 (from Yahoo Finance), not on any individual equities. I'm trying to discover how long a 'long term investment' need be, if one invests in an S&P 500 index / ETF / iShare. (I'm no expert on the subtleties of those investment vehicles). My understanding is that they track (as best they can) the value of the index by investing in the stocks that compose the index. Therefore I guess that when company in the S&P 500 goes bust the effect that has on one's investment closely matches the effect it has on index value. I'll research that. Assuming this is true, I think we needn’t be concerned by the bankruptcy issue that you make. But please correct me if I'm wrong about that - I'm interested. I'll try to add TSR in the next analysis too.
- mattmaroon 18y agoIt's not interesting, it's just wrong. Even if the total market averages 10%, that's counting bankruptcies. It's not a median or a mode, it's a mean.
- mixmax 18y agoMatt, you're right. I thought he was looking at a portfolio of individual stock, not an index where bankruptcies are supposedly included. My bad...
- mixmax 18y agoahh, yes you're tracking S & P 500. Sorry, I probably read the aricle a little quickly... I don't know for sure, but I would think you're right in your assertion that the index incorporates the risk of companies failing.