Many investors try to beat the market by picking individual stocks or investing in actively managed funds. But over the long term, the vast majority of individual stocks and actively managed large-cap funds have underperformed the S&P 500 (^GSPC +0.23%).
The reason is simple. The S&P 500 is rebalanced each quarter to always include the 500 largest companies in America. Rapidly growing companies are added to the index, while the weaker ones get pruned. It’s tough for individual stocks or funds to match that efficiency.
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The S&P 500 has generated an average annual total return of about 10% since its inception in 1957. That’s why John Bogle, Vanguard’s founder and the creator of the first S&P 500 index fund, told investors, “Don’t look for the needle in the haystack. Just buy the haystack.”
But today, the S&P 500 looks historically expensive at 29 times earnings. That’s well above its average price-to-earnings ratio of 20 to 23 over the past three decades. Therefore, it might seem smarter to avoid popular S&P 500 ETFs — like Vanguard’s S&P 500 ETF (VOO +0.28%) — and park your cash in CDs or T-bills while interest rates are still elevated. However, there’s one thing every S&P 500 investor should consider before making that move.
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Fortune favors the patient
Peter Lynch, one of the few fund managers who consistently beat the S&P 500, famously said that “everybody in the world is a long-term investor until the market goes down.” In other words, the S&P 500 delivers big long-term gains to investors who can tune out the near-term noise.
In just the past 20 years, the S&P 500 dropped 57% from Oct. 2007 to March 2009, 34% from Feb. to March 2020, and 25% from Jan. 2022 to Oct. 2022. Those drawdowns — which were caused by the Great Recession, the COVID-19 crisis, and the Fed’s rate hikes — drove many of those “long-term” investors out of the market.
However, a person who had invested $1,000 in the S&P 500 on the first trading day of 2007 and reinvested their dividends would still be sitting on about $7,650 today. That same investment in a 20-year Treasury in 2007, with reinvested interest, would only be worth about $2,500 today.
Therefore, if your main strategy is to simply invest in the S&P 500 for the long term, it doesn’t make sense to fret over interest rate hikes, geopolitical conflicts, or other near-term issues. If you believe the top 500 companies in the U.S. will grow much larger over the next few decades, it’s still a great idea to buy the haystack, forget about it, and reap those rewards in the future.
