Investing in the S&P 500

Summary

In this video, Ben Felix discusses the advantages and limitations of investing in the S&P 500. While the index has historically delivered impressive returns, especially since the financial crisis, its future performance is unlikely to mirror past success. Felix explains that the S&P 500 is actively managed by a committee and does not fully represent the US market, let alone global opportunities. He highlights the benefits of global diversification, supported by studies, and argues for a globally diversified portfolio as the best investment strategy, as it balances risk and provides greater potential for long-term growth.

Takeaways

• 😀 The S&P 500 has experienced impressive growth recently, thanks to subscriber engagement, making the project feel worthwhile for the creator.
• 😀 The S&P 500 represents 500 large US stocks, covering around 80% of the US stock market capitalization, with approximately $3.4 trillion invested in index funds tracking it.
• 😀 Although the S&P 500 has historically performed well, its exceptional returns since the 2008 financial crisis are statistically unlikely to repeat in the future.
• 😀 The S&P 500 is not a passive index; its constituent stocks are selected by a committee, which introduces a human element that makes past performance even less likely to repeat.
• 😀 Despite covering a large portion of the US stock market, the S&P 500 does not represent the entire market, as there are about 3,000 other stocks not included in the index.
• 😀 Investing only in the S&P 500 could lead to missing out on global equity premiums, as global markets often offer higher returns and diversification.
• 😀 Research shows that only a small percentage of global stocks (1.3%) have driven most of the wealth creation, emphasizing the importance of diversification to capture equity premiums.
• 😀 While some argue that the S&P 500 provides global exposure due to its foreign revenues, it does not offer the same benefits as directly investing in international markets.
• 😀 Studies show that a globally diversified portfolio of stocks, including non-US markets, has historically provided better risk-adjusted returns and lower volatility than solely investing in the US market.
• 😀 The global stock market has had varying performance over time, and relying heavily on the US market increases the risk of poor outcomes in case market dominance shifts, as seen with Japan's market decline in the 1990s.
• 😀 Valuations matter for future returns. The S&P 500 is currently highly valued, which suggests that future returns could be lower compared to other less expensive markets like Canadian or international stocks.

Q & A

What is the S&P 500, and why is it so well-known?

The S&P 500 is an index of 500 large US stocks that cover around 80% of the total US market capitalization. It is one of the oldest and most recognized stock indexes in the world.

How much money is invested in the S&P 500 index?

As of the data from the S&P Dow Jones Indices, approximately 3.4 trillion US dollars are invested in index funds that track the S&P 500.

What makes the past performance of the S&P 500 so remarkable?

From 1980 through May 2019, the S&P 500 has consistently outperformed the CRSP 1-10 US Total Market Index while being less volatile. Additionally, its performance from March 2009 to October 2018 was so strong that statistical analysis showed it was almost impossible to achieve.

Why is the future performance of the S&P 500 likely to be different from its past performance?

Past performance does not guarantee future results. Statistical analysis of the S&P 500's recent performance revealed that the chances of it repeating such extraordinary returns in the future are extremely low.

Is the S&P 500 a truly passive index?

No, the S&P 500 is more actively managed than most people realize. The stocks included in the index are chosen by a human committee, not by an algorithm, meaning there’s a level of discretion in its composition.

What does the S&P 500 miss by only including 500 stocks?

The S&P 500 includes just 500 of the approximately 3,500 stocks in the US market, leaving out a significant portion of potential returns from smaller companies and global stocks.

Why is global diversification important despite the S&P 500's international exposure?

Although the S&P 500 companies generate a substantial portion of their revenue globally, the index itself is heavily focused on the US market. For true global diversification, investing in a broader mix of international stocks is necessary.

What did Hendrik Bessimbinder's study reveal about global stock returns?

Bessimbinder’s study found that only 1.3% of the 62,000 global stocks studied were responsible for all the wealth creation beyond the returns from US Treasury bills. This highlights the importance of diversification to capture global equity premiums.

What is the issue with betting only on US stocks or the S&P 500?

Betting solely on US stocks increases the risk of missing out on the potential growth of global markets. The US has not always dominated global stock markets, and investing in only US stocks can lead to suboptimal outcomes if other regions outperform.

How do the S&P 500's valuations compare to other markets?

As of June 2019, the S&P 500 had a price-to-earnings ratio of 20.5, significantly higher than Canadian stocks (14.6) and international developed stocks (14.7). High valuations suggest that future returns may be lower, making it risky to rely solely on the S&P 500.

What is the recommended strategy for most investors based on the video?

The recommended strategy is to invest in a globally diversified portfolio, using total stock market index funds, which capture returns from both US and international markets while reducing the risk of concentrated exposure.