Understanding the Real Price

The goal of this newsletter is to help you better think about your money so you can make good decisions about your future and investments in that future. It’s a simple premise. But, not an easy one to execute given human emotions and biases. One of the biggest problems comes from thinking the best decisions for our future come from our past, our most recent past.

Recency bias is a powerful force. In a world inundated with information, the latest bits that pass through our brain often carry the most weight. As such, our latest investments occupy our thinking.

How ever they’ve performed to this point is how we expect them to perform into the future. If they were good investments, we expect that to continue into the future. If they were poor investments, we anticipate that into the future as well.

How ever they’ve performed to this point is how we expect them to perform into the future.

This can be true no matter the investment—real estate, private equity, race horses, baseball cards, art, jewelry, stocks, bonds, currencies and commodities.

Unfortunately, that kind of thinking does not factor in the enormous change that’s always occurring in the world. After all, few of us travel by horseback anymore. Not many of us still get water from a well. And, almost nobody rents movies from a video store. Remember, Blockbuster? Yeah, its dominance was not all that long ago. Now, I think there’s one novelty store somewhere in Oregon.

For this reason, it’s too simplistic to think about the past as a great predictor of the future. It can be helpful, but you still need more information. You still need to do a basic SWOT analysis—strengths, weaknesses, opportunities, threats.

For this reason, it’s too simplistic to think about the past as a great predictor of the future.

You also need to think about price: what you are paying for every dollar of earnings. In my opinion, this is vital for long-term investors. Yes, in the short term, investments can move on momentum, regardless of value. But, over the long-term, the price you pay for earnings and the growth of those earnings will determine performance.

Unfortunately, this price is not the one you see quoted everyday on the news or financial websites. Yes, the S&P 500’s current level is in the 5470 range. But that tells us nothing about the underlying price on earnings. So, let’s dive into that price, that value.

First things first, you cannot invest directly into the S&P 500. You have to buy a fund that tracks the index. There’s a disclosure below, but I just wanted to make that clear.

First things first, you cannot invest directly into the S&P 500.

We’re going to take Prince’s advice and party like it’s 1999. At that time, according to Yardeni Research, you were paying a hefty $24 for every dollar of earnings. If you would have made an investment into the S&P 500 on January 1st, you would have received a compounded annual return of just under 6%. In plain English, a $100,000 investment then would be worth about $439,000 today.

Fast forward to New Year’s 2003. You’re now paying just $16 for every dollar of earnings . Since then, you’ve received a compounded annual return of 8.77%. Here, a $100,000 investment would be worth more than $613,000 today.

Now take a look at New Year’s 2009. You paid about $11 for a dollar of earnings. And, that translated to an annual return better than 12%. An investment of $100,000 would total close to $600,000 today.

You paid about $11 for a dollar of earnings.

You’ll notice, the investment in 2009 is worth more today than the investment made a full decade earlier.

This is not to say you can time the markets with precision. That’s not real. But, you can stack the odds more in your favor if you pay attention to price and seek to get more value from every dollar you invest.

So, what about today’s market? According to Factset, today’s price is closer to $21. That’s relatively high and above the $18 average over the last decade. If this were an average market, the index level would be closer to 4700.

According to Factset, today’s price is closer to $21.

Now, that doesn’t mean there’s imminent danger. That doesn’t mean you shouldn’t invest. Earnings could accelerate without a major selloff. But, today’s pricing does argue for prudence and balance.

This is especially true if you’re an older investor, with a large portfolio and you’re coming up on a major goal like retirement. You likely don’t have the benefits of investing large sums during a future selloff. You’ll have to just ride the wave.

Here’s the point: there’s a common misconception the market moves in a linear fashion. Because the long-term average return is about 10%, you may come to expect that return each and every year, like clockwork. And, there’s a misconception the price you pay for earnings is always the same.

Here’s the point: there’s a common misconception the market moves in a linear fashion.

As you could see above, that’s not the case. The S&P 500 you bought in 1999 was different than the one in 2003 and 2009. And, those differences drove vast dispersions in performance.

The reality is that market conditions and pricing are always in flux. Right now, AI is all the rage. It’s been driving most of the return here in the short-term. But, that doesn’t mean all AI investments are prudent at any price.

So, the best way to help protect yourself and your future is to demand good value from each of your investments. That’s what we aim to do for our clients. Our goal is to help reduce risk so they can better achieve all their financial goals.

So, the best way to help protect yourself and your future is to demand good value from each of your investments.

This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.

All views/opinions expressed in this newsletter are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC.

The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. Indexes are unmanaged and do not incur management fees, costs, or expenses. It is not possible to invest directly in an index.