Good investing is really simple: get yourself into the position of owning a portion of a profitable business or property, keep it as long as possible, and live off the resulting stream of dividends and appreciation. For even greater wealth, just reinvest the earnings into still more profitable ventures.
This high-level view is liberating because it allows you to tune out of what the politicians and financial pundits of the day are up to. Joe Trader is raving on his TV show about interest rates and technical analysis, and Josephine Doomer is speculating about the role of precious metals “once all this fiat currency goes up in smoke”. While they keep speculating, we’ll keep quietly owning the show and working in our garden or woodshop while our stable of thousands of companies and their millions of employees remain innovative and productive on our behalf.
Although you don’t need to know much more than the above for successful investing and even early retirement, many of us enjoy going further and learning about how it all works behind the scenes. I still like to read a book or two on investing, economics or the stock market every year, and I am also fascinated by the trends of world history and finance that slowly evolve over the decades and even centuries. This helps you take the long view on finance, which in turn brings you back to the start of the first paragraph so you can remain relaxed.
To make this Long View even more fun and convenient to absorb, I’ve commissioned the creation of a very handy (and free) interactive piece of software called IndexView, because I think it paints the picture of US economic history in a uniquely useful way. Let’s go straight to the tool itself, and then explain what is so cool about it immediately afterwards. To use it, try rolling your mouse wheel, pulling that scrollbar left and right, and using the pulldown and date boxes.
First of all, let’s give credit where it is due: This tool was entirely programmed by a young (and completely brilliant in my opinion) reader named Tristan Hume. I met this guy last year at an Ottawa MMM meetup, and he whipped out an iPad running a slick app he had created called StashLine. It is a financial planning app designed specifically to help plan the early financial freedom that is so rare outside of readers of this blog. I mentioned my own idea: a web-based graph that lets you really easily see the returns of the stock market with and without dividend reinvestment, as well as other useful data, over recorded US history. He emailed me a few days later with an early version, and we’ve been developing it ever since*. At this point, I think it is great enough to share with you.
Why This is So Important
The stock market is still widely misunderstood. Beginners dive in and think you can outsmart it by identifying the next “head and shoulders formation” (you can’t). Others repeat common misunderstandings like “The stock market actually returned nothing for 25 years between 1929 and 1955″. This is incorrect, because companies were paying dividends like crazy during those years, and if reinvested the wise shareholder would have returned almost 7% compounded – not bad for the famously worst period in recent investing history.
To look at a more contemporary example, I like to be able to identify when stocks are on sale. This golden opportunity pops up when the stock market’s overall price is cheaper than average. In June 2011, I did the analysis for you and determined that they were priced just about right: the 1-year price-to-earnings ratio was about 16.2. If you had bought stocks then, you’d have seen compounded annual returns of about 16% to today.
Just two months later, the pundits and doomers got scared and caused a crash, and the stocks were on sale. I wrote about it again in an article called A Summer Clearance on US Stocks! Plugging the dates into IndexView again, smart readers who bought at that moment would have seen returns over 20% per year to this point.
Understanding history is useful, but it is still only a general guide in predicting the future. Right now, for example, our stock market is more expensive: the P/E ratio is over 19, and the even more meaningful trailing 10-year P/E (also called “Shiller P/E” or “P/E10“) is over 25. Is this a scary bubble and a terrible time to invest?
Consulting the IndexView oracle above yet again, we can use the dropdown to select “Shiller P/E ratio” and see what happened the last time stocks were this expensive. Roll that mouse wheel to zoom way out. It was at a similar price in 1903, then again in the ’20s, 30s, 60s, 70s, and then way more expensive for much of the time since the Internet was invented. The peak of overpricing was in the year 2000, when the P/E10 was over 40.
Going back to S&P500 with dividend reinvestments, we can see what has happened to people who invested in these situations before:
Investing in the worst time of 2000 (P/E10 was over 40), you would have a seen annual compound returns to date of just under 4%. Pretty terrible by stock market terms, but still an overall increase in your money of 64%, because 14 years is quite a long time, and compounding is some powerful shit.
More significantly, let’s see what happens if we invest at some earlier time the market was at its current moderately expensive P/E10 of around 25. Set IndexView to invest from 1996 to 2014. Over that 18-year period, investors have made a compounded 8.2% return, or a total of 321% before inflation.
You would probably get quite excited and proclaim yourself to be a real estate genius if you bought a $200,000 house in 1996 and found it to be worth $642,000 today. But to the long-term stock market investor, this is just typical performance.
I think IndexView is a great educational and investing tool, and thanks to Tristan for building it. If you like it, set yourself a bookmark and share it around the web so others can share the benefit and encourage further development of a promising** new set of financial tools.
*and it’s still a work in progress, of course. If you have suggestions or bug reports for Tristan, feel free to mention them in the comments for future development.
**And by the way, this guy just finished high school. If you’re running a tech company and in search of unusually bright talent, you might get in touch with him before it’s too late ;-)