This investment strategy has earned 103 out of 103 times | personal financing
Regardless of whether you are a Wall Street professional or an everyday investor, 2022 has historically been a challenging year. The Standard & Poor’s 500 (SNPINDEX: ^GSPC)which is often seen as a measure of stock market health, turned out to be the worst first-half return since 1970. Meanwhile, Nasdaq Composite (NASDAQINDEX: ^ IXIC) It fell as much as 34% below its mid-November high. In other words, both widely followed indicators entered a bear market aggressively.
These declines come on the heels of consecutive quarterly corrections in US GDP, as well as an inflation rate of 9.1% in June 2022. This is the highest inflation reading in just over four. contracts.
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While history suggests that the S&P 500 and Nasdaq are likely headed lower, one investment strategy has been guaranteed to make impatient investors richer.
History is not Wall Street’s friend – at least in the short term
Before we get to the solid strategy that hasn’t failed long-term investors for over a century (and more), let’s tackle the elephant in the room: history. As much as investors love when the stock market is trending higher, three indicators with a successful track record of calling bear market bottoms suggest that the S&P 500 and Nasdaq Composite should drop further.
For example, forecast margin use for debt each of the last three bear markets before they occur. “Marginal debt” is the amount of money investors borrow from the brokerage, with interest, to buy or sell short securities. While it is perfectly normal to see an increase in margin debt over time as equity increases in value, it is not normal for outstanding margin debt to increase rapidly in a short period.
Since the beginning of 1995, there have been three cases in which the debt margin has increased by a minimum of 60% over a 12-month period (TTM). It happened right before the dot-com bubble burst, which eventually drove the S&P 500 down to 49% of its value. It happened again just months before the onset of the 2007 financial crisis, sending the S&P 500 down 57%. Finally, it happened in 2021, and we’ve already seen the S&P 500 lose as much as 24% of its value. This indicator indicates the possibility of more downside.
The price-to-earnings (P/E) ratio of the S&P 500 (also known as the cyclically adjusted price-to-earnings ratio, or CAPE ratio) is another worrisome indicator in the short term. The Schiller P/E ratio examines inflation-adjusted earnings over the past 10 years, rather than the traditional P/E ratio, which exceeds TTM.
Since 1870, there have been five instances in which the Shiller P/E ratio for the S&P 500 has exceeded and settled above 30 in a market uptrend (Shiller’s P/E reached 40 in January 2022). The previous four cases in which they occurred resulted in decreases ranging from 20% to 89% for the normative index. While a major drop of 89% is incredibly unlikely today due to the various monetary and financial tools available, a bear market has been the minimum expectation for the broader market when valuations stretch.
The third indicator of concern is the S&P 500 futures P/E ratio. The forward price-to-earnings ratio examines a company’s stock price—or in this case, the index’s point value—to projected earnings per share on Wall Street in the upcoming fiscal year. Historically, the S&P 500 futures price-earnings ratio has fallen between 13 and 14 during bear markets. It was still at 16.3 as of last weekend, indicating further decline.
This investment strategy has been hitting 1.000 over a century
However, there is an investment strategy that, for more than a century, has made bear market crashes and stock market corrections a moot point. Best of all, patience is the only thing required for the success of this investment strategy.
Each year, stock market analytics firm Crestmont Research releases data on the 20-year total returns, including dividends paid, for the S&P 500 dating back to 1919. For example, if you want to achieve total returns for a period of time 20 Year End Year In 1977 Crestmont was studying the total return for the years 1958 to 1977. The most recent report from Crestmont provided the 20 year total return (presented as an annual average) for all 103 end years from 1919 through 2021.
Results? If you bought the S&P 500 tracking index at any time since 1900 and (key point) Hold this position for at least 20 yearsI made money – and often a lot of it. Approximately 40% of the end of the 103 years resulted in an average annual total return of 10.9% or higher. Comparatively, the average annual total return of the S&P 500 for 20 years was just under 5% twice during the 103-year end. This data is precisely the reason why billionaire Warren Buffett is suggesting investors to buy the S&P 500 Index Fund.
The most popular index funds to leverage a seemingly foolproof investment strategy are SPDR S&P 500 ETF Trust (NYSEMKT: spy) and the Vanguard S&P 500 ETF (NYSEMKT: VOO). While both index funds attempt to reflect the daily price action of the S&P 500, there is one notable difference. Although the SPDR S&P 500 ETF Trust offers a reasonably low net expense ratio of 0.09%, the Vanguard S&P 500 ETF has an edge over its competitor with a net expense ratio of just 0.03%. In other words, only $0.30 of every $1,000 invested will be allocated to management fees with the Vanguard S&P 500 ETF.
It’s a very small price to pay for the opportunity to ride the S&P 500 Index higher and take advantage of what has been an unstoppable investment strategy for over a century.
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Shawn Williams has no position in any of the listed stocks. Motley Fool has positions in and recommends the Vanguard S&P 500 ETF. Motley Fool has a disclosure policy.