In January of 1982 (the month and year of my birth) three people invested $10,000 of their money in stocks: Joe Schmoe, Jane Lane, and Bob Cob. Each took a different approach.
Joe, who didn’t want to think about his stocks, invested his $10,000 in an S&P 500 index fund; through the fund he automatically owned 500 of the leading American public companies. He didn’t have to think about anything. He just left the money invested in the fund, and owned the 500 top public companies in the U.S.
Jane thought she could do better than just owning the 500 leading public companies in the U.S. She thought she could pick and choose which companies and stocks would outperform. She carefully researched individual companies and invested her $10,000 in individual stocks, and followed a disciplined investment process.
Bob also thought he could do better than just owning the 500 leading U.S. public companies. He invested some of his $10,000 in individual stocks and the majority in mutual funds he thought would outperform. Unlike Jane, however, Bob didn’t follow a disciplined process. He got carried away by the sway of the stock market, sometimes buying when stock prices were overly-expensive and selling when they were overly-cheap.
Joe, Jane and Bob each left their money invested for 42 years, until the end of 2023.
Here are their results:
Joe, who didn’t spend an iota of time thinking about his stocks—he simply owned the 500 top U.S. public companies—had his $10,000 initial investment grow into $1 million. This equates to an 11.6 percent average annual rate of return.
Jane, who carefully curated her portfolio of stocks, researching, following and selecting individual companies to invest in, had her $10,000 initial investment grow into $2 million. This equates to a 13.5 percent average annual rate of return.
Bob, who, like Jane, gave his investments much thought, but unlike Jane, didn’t follow a disciplined process, had his $10,000 initial investment grow into $600,000. This equates to a 10.2 percent average annual rate of return. The high-fees of the mutual funds he invested in proved too big of a barrier to overcome for even the skill of the investment managers running the funds. They achieved returns that were higher than the S&P 500—13.5 percent per year—before fees; but after fees, which averaged two percent per year, their returns trailed the S&P 500.
Horsepower
A couple things stand out in our example.
The horsepower Joe got on the money he invested in stocks without giving it any effort. An automatic investment—invested in the leading American public enterprises—grew in value from $10,000 to $1 million. That’s simply astonishing. That shows the horsepower that the overall stock market has. That the leading public companies have. Most of this return was driven by earnings growth; by business performance. Businesses did well. The horse ran fast. The jockey didn’t have to do much—just ride the horse.
By adding some skill and having discipline and putting in the time you can achieve above average results. It is difficult to do but it can be done. And if you can achieve a slightly above average rate of return over time, it can add up to millions as it did with Jane. Her investment grew $1 million more than Joe’s. And this was on just a single $10,000 investment.
By attempting to add skill, if you fail to, it can have the opposite effect than in the point above. Bob’s $10,000 investment grew to $600,000—$400,000 less than Joe’s, who did nothing—because it was misallocated. The mutual funds it was invested in failed to outperform after fees; and the individual stocks it was invested in underperformed because Bob didn’t follow the right investment process.
Underperforming by a small margin can have a massive impact. Bob achieved a 10.2 percent average annual rate of return on his stocks—just 1.4 percent less than Joe. This resulted in Bob’s investment growing by $400,000 less than Joe’s. Small percentages add up—big time—over time in investing. Be careful trying to knock the ball out of the park. You want to make sure you make good contact.
Adding horsepower to your stocks, above the average of the overall stock market, is really difficult to do; 90 percent of professional investment managers, after fees, fail to do so. If you attempt to, you need to be rock solid in your philosophy in picking stocks and stock mutual funds.
Your Horsepower
What will drive the horsepower you get on your money invested in stocks is:
The quality of the companies (stocks) you or your investment manager select
The price at which they’re selected at
How much time and effort you dedicate to the pursuit
Points one and two being the most important.
If the stocks (businesses) you own are high quality and bought cheap they will do really well. Your returns will be high. The horse will run fast. If they are bought bad and dear, their performance will be poor. It’s as simple as that.
The S&P 500, from 1982 to 2023, returned 11.6 percent per year largely because the businesses did well. The horse ran fast. Most of this return was comprised of earnings growth. The 500 top U.S. public companies grew at a good clip. They grew sales, trimmed costs, and paid healthy dividends—all good for investors.
How well the S&P 500 does in the years ahead depends on how the businesses do. How well the horse runs.
How well you do on your stocks, whether you invest in the S&P 500, individual stocks, or mutual funds, depends on how well the companies behind those stocks do.
Stocks are nothing more than businesses. When you invest in a stock, or mutual fund that invests in stocks, you are investing in businesses. You become a business owner. Your economic fate becomes tied to those businesses.
That is why the quality of those businesses, and price at which you invest in them, is so important. It will dictate your fate.
A good horse with a light jockey will run fast.
A bad horse with a fat jockey will run slow.
Warren Buffet, in a letter to his investment partners in 1969, said:
I think about them as businesses, not “stocks”, and if the business does all right over the long term, so will the stock.
Think of your stocks or mutual funds as businesses. Because that’s what they are, collections of businesses.
John Bogle said it like this:
In the long run, stock returns have depended almost entirely on the reality of the relatively predictable investment returns earned by business . . . It is economics that controls long-term equity returns; the impact of emotions, so dominant in the short term, dissolves . . . the stock market is a giant distraction from the business of investing.
Emotions may cause stock prices to swoon in the short term—sometimes dramatically. But what drives them in the long term is business performance.
Selecting superior businesses, at superior prices, is essential to getting superior returns in stocks.
More Horsepower
The only reason to try to get more horsepower out of your money invested in stocks than you can by investing in an index like the S&P 500 is if you reasonably believe you can outperform the overall market. And the only reason for believing this is historical evidence.
If you select individual stocks, you need to demonstrate a track record of outperformance. You need to track your returns against the overall market. The only reason to pick individual stocks is if you can prove you can do better than the overall market over time.
The only reason, likewise, to invest in mutual funds managed by professional investment managers is if they can prove, and have proved, that they can at least match the performance of the overall market over time. If they haven’t, why invest in them?
Track Record
Your investment approach with stocks should be dictated by a strong track record.
Only invest in mutual funds that have exhibited a strong track record, and that take a sensible investment approach buying quality companies at a reasonable price; that are able to at least match the performance of the overall market over time after fees.
Only invest in individual stocks if you’ve adequately learned what’s necessary to pick individual stocks and have demonstrated a good track record.
If you or an investment manager can’t or haven’t, why not just invest in an index like the S&P 500—and reap higher returns over time? The only reason to expect a better result is if one has been demonstrated in the past.
Bottom Line
The horsepower on your money invested in stocks is driven by business performance.
The performance of the businesses you own will drive your returns.
Own good businesses at good prices, and you’ll get good horsepower; own bad at bad, and you’ll get bad.
Own an index like the S&P 500—and you’ll outpace 90 percent of horses on the track.