I Analysed 100 Years of Index Funds, This Is What I Found

Summary

This video challenges the conventional wisdom of using long-term stock market performance to predict future returns. It delves into the complexities of historical data, highlighting issues like survivorship bias and the unreliable nature of backtested data. The speaker explores the flaws in past performance analysis, questioning the accuracy of older market data, and discusses how modern market dynamics, sector changes, and evolving rules make past comparisons less useful. Ultimately, the video encourages investors to approach historical returns with more caution and consider a broader range of possibilities when planning for the future.

Takeaways

• 😀 Past stock market performance isn't always a reliable indicator of future returns.
• 😀 The S&P 500 index, introduced in 1957, only became investable in 1976 with the advent of index funds.
• 😀 Global investors have limited historical data, and much of the available information relies on backtested or hypothetical data.
• 😀 Survivorship bias skews the perception of market success, as failed companies or those that disappeared aren't part of historical data.
• 😀 Even academic research on stock market returns is subject to error, as some data may have been missed or misjudged in earlier studies.
• 😀 Data collection methods are evolving, and the rules for categorizing stocks and measuring returns have been revised multiple times, especially in the last few decades.
• 😀 The global stock market today is very different from the one in the 19th century, with sectors like tech dominating, compared to railroads being the major player back then.
• 😀 The comparison between markets today and in the past is like comparing jet engines to horses—markets have evolved significantly over time.
• 😀 Stock market returns data before the 1990s is less reliable, and much of the historical data is reconstructed and based on assumptions.
• 😀 Investors should consider a range of potential returns, not just historical averages, to better plan for future investment outcomes.
• 😀 The US stock market has outperformed others by 2-3% annually since 1900, but this does not guarantee future success, and choosing one market over others can be risky.

Q & A

What is the main message of the video script?

The main message is that past market performance is not a reliable predictor of future returns. The speaker encourages investors to question historical data and understand that it may be distorted by factors like survivorship bias and incomplete records.

What is survivorship bias, and how does it affect market data?

Survivorship bias refers to the distortion that arises from focusing only on successful outcomes, such as companies that survived or thrived, while ignoring those that failed. In market data, this bias can lead to an overestimation of historical returns because failed companies, whose data is often not available, are excluded.

How does the speaker suggest investors view historical returns?

The speaker suggests that investors should approach historical returns with caution and not treat them as guarantees for future performance. They recommend 'stress testing' a range of returns rather than relying on average figures from the past.

What was the significance of the introduction of the S&P 500 and the MCI World Index?

The introduction of the S&P 500 in 1957 and the MCI World Index in 1986 marked important milestones in tracking the performance of markets. However, it took until 1976 for a publicly available index fund to track the S&P 500, and global investors had to wait until 1986 for the MCI World Index, highlighting gaps in the availability of market data in earlier periods.

What issue does the speaker raise regarding backtested performance data?

The speaker highlights that backtested performance data is hypothetical and often not reflective of actual historical performance. This data can be misleading as it doesn't account for the many variables that may have changed over time, such as market structures and available information.

Why does the speaker mention the study of cats falling from buildings?

The study of cats falling from buildings is used as a metaphor for survivorship bias. The study found that cats falling from higher floors survived more often, but this was because only the survivors were taken to the vet, creating a false perception that falls from higher floors were safer.

What is the significance of Dimson, Marsh, and Storton's work on stock market returns?

Dimson, Marsh, and Storton's work is considered the 'gold standard' of stock market return data, providing a rigorous, long-term analysis of global stock market performance. Despite their efforts to combat survivorship bias, their work still faces challenges due to the incomplete or lost records from earlier periods.

What does the speaker mean by 'the rules of the game' changing over time?

The 'rules of the game' refer to the evolving standards and methodologies for measuring and tracking market performance. For example, changes in how sectors are classified, the introduction of free float weighting for indexes, and improvements in data collection have all altered how market performance is understood.

Why does the speaker compare the stock market today to the market in the 19th century?

The speaker compares the stock market today to the 19th century to highlight how much the market has changed. In the 19th century, the dominant sector was railroads, while today, technology dominates. This comparison underscores the challenges in using historical data to predict future performance, as the market has evolved significantly.

What does the speaker suggest about the US stock market's historical performance?

The speaker points out that while the US stock market has historically outperformed other markets by 2-3% per year since 1900, this may be an example of survivorship bias. Investors today can only know which markets have performed well, but in the past, they had no way of knowing which markets would succeed, making such predictions speculative.