(note: this post has been updated with data up to 1st May 2016)
These days, the S&P500 is reaching new records and the close on Friday was at 2116. News outlet are now able to regularly announce that a new record has been established. Comparing with the peak values of the year 2000, the S&P500 has climbed 40%, from its 1500 highs.
But has it really? Was it a good idea to invest in 2000 since the index is now 40% higher?
It was not a good idea. Inflation took it all away.
S&P500 adjusted for inflation
Inflation is one of those powerful and invisible forces : it is almost negligible for our day to day lives but compounded over long periods of time, it has significant effect on an economy’s real purchasing power, forcing it to become more efficient at a faster pace that inflation’s pace to maintain and increase its purchasing power.
For now, inflation in the US for the last 12 months is 0%. Difficult to make it more invisible. But it’s not always been the case and this is important to keep in mind when looking at all the prices around us, particularly stocks and indices, as they are reported in their nominal values.
You can adjust the chart to zoom in/out of a period
A good illustration of the effect of inflation is the period 2000 – 2015.
In nominal terms, after the year 2000 peak, the S&P500 reached it again briefly in 2007, then again in 2013 and now sits 40% higher than in 2000. However in real (ie. inflation adjusted) terms, the index reached the peaks of the year 2000 again only in late 2014. In the last 15 years, the S&P500 has only generated 3.7% of real returns.
Another good example is visible between 1956 and 1985. While the nominal value of the index increased 300%, inflation was high and the real value remained flat. Investments made in the S&P500 in 1956 basically went nowhere for the next 30 years.
The following 30-year period (1985-2015) however paid handsomely and generated 450% of real returns.
When it comes to investments over period of 10+ years, prices need to be looked at from a real, inflation adjusted perspective. Nominal prices fluctuations can be widely deceptive.
S&P500 Total Returns adjusted for inflation
One easy way to fight inflation is to automatically re-invest the dividends.
I have found it difficult to get easily accessible data online that would quantify the benefits of re-investing all dividends.
So here is a chart with the S&P500 Total Returns since 1950, adjusted for inflation.
In the period 2000 – 2015, the index with dividend reinvested achieved a 37% real return vs the 3.7% without the dividends!
Similarly, in the period 1956 – 1985, the real total return has been 200% where dividends were reinvested.
This analysis for the S&P500 applies to individual stocks as well. Since many central banks have a goal to maintain inflation close to 2%, a stock (or an index) that doesn’t gain at least 2% per year is not only stagnating but losing real value.
Investing now with a long time horizon will necessarily be affected by inflation and its impact is clearly visible on those charts. We do not have control over inflation but it is very likely that the central bank will work tirelessly to bring it higher than 0%, therefore reducing the current real value of all assets.
It is also possible that future returns will not look like the past returns, as we see that each 30-year period can bring significantly different returns.
The good news is, as we see on those charts, that regardless of the financial situation, having the dividends automatically reinvested is a very easy way to significantly improves the real returns over the long term.
Nick – MoneyMiner
Photo credits : PhotoSteve101