The subprime returns of index fund investing

The problem is that if you are talking about passive indexing, that is something that is really free-riding on other people’s work,” Shiller said. “So people say, ‘I’m not going to try to beat the market. The market is all-knowing.’ But how in the world can the market be all-knowing, if nobody is trying — well, not as many people — are trying to beat it? … “It’s kind of pseudoscience to think these indexes are perfect, and all I need is some kind of computer model instead of thinking about business.

— Robert Shiller

Shiller is no dope. He’s the man — literally — who collected the data on the history of the S&P500, bond prices, inflation rates, housing data… going back to 1871. He organized all of this data and then… gave it away for free so everyone could better understand how stock markets, housing markets, inflation, and the economy in general works. 

There are few people alive today who understand the general nature of financial markets better than Shiller — at least in a quantitative sense.

Which is why I find it highly amusing when I listen to the shnewz about how the Dollar is doing this and the Yen is doing that and how the stock market does 10% a year. 

It’s just not that simple, buckshot.

Here’s the reality of it:

If you invested $1 from the beginning of November 2018 to the end of December, you lost over 15% of your money. That’s the sh*t that scares people. But, if you invested that same dollar from the end of December 2018 to yesterday (Nov 8, 2019 for those of you reading this in the future), then you made about 31% on your money. Nobody is scared of making those kinds of gains.

Now… if you invested $1 PER MONTH, every month, for the entirety of 2018 and 2019, then you would have experienced a LOSS of about 9%, plus you would have earned some dividends, so maybe you’d have only lost about 6% of your savings, on net.

I’ve used Robert Shiller’s database and also public databases for popular index funds, like VFINX to try and reconstruct what an investor actually received from years and years and years of investing. The VFINX is a real interesting one because it’s Vanguard’s first index fund and the price data is public information. So, when you hear “the stock market averaged 12% annually”, ignore it. You can’t invest in an index. You can only invest in investment products, like VFINX or some other mutual fund or an individual stock or something else.

So, the burning question is… after 39 years of investing, what have the Bogleheads actually earned on their investments? If they put every single dime they saved into VFINX, they earned about 7.5% after taxes (give or take — I don’t have end of month data for November or December obviously). That’s not too bad, but that also doesn’t include expenses for term life insurance (most of those guys are part of the “buy term, invest the rest” crowd) which means those 7.5% returns aren’t really 7.5% returns because a lot of that money was siphoned away to pay for term life insurance premiums over the past 40 years. 

And… this assumes an investor started investing waaaaaaaay back in 1980 — arguably the best time to be alive in the stock market. The past 20 years haven’t been nearly as kind to investors so they’ve have to be a lot more discerning about the types of things they invest in… unless you’re a “passive investor”, in which case you just keep throwing money at stuff you don’t understand for subprime investment returns.

All this to say you cannot predict your future investment returns, which is why stuff like whole life insurance exists. Incidentally, MassMutual did a dividend study over the same 39-year period. Across most age groups, policyholders earned about the same amount as an investor would have earned net of taxes. 

This astounded even me. I kind of thought there would have been an advantage to investing during some of the greatest bull markets in American history, but… not really. I mean there was some advantage but not a huge one. 

Which means, investing really did come with a lot of risk, considering the whole life policyholders took zero risk for their returns on cash value over the last ~40 years to achieve very similar results. 

None of this would be convincing to stock market True Believers though. But, it is food for munching if you’re on the fence about what to do with your savings.

David Lewis, AKA The Rogue Agent, has been a life insurance agent since 2004, and has worked with some of the oldest and most respected mutual life insurance companies in the U.S. during that time. To learn more about him and his business, go here.