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Let's explore a sustainable investing strategy led by numbers.

A YOLO 'antidote'...

Last week I wrote about outperformance in regards to the S&P 500.

In subsequent conversations with Tim Vollans I touched on the obsession that some sections of the markets have with growth.

To them, growth appears to be the be-all and end-all, yet it seems to me that growth needn’t be our only goal.

Capitalism in its current form is reliant on growth and the trickle-down effects that it can create. In recent years economists such as Thomas Pickety have highlighted the increasing inefficiency of this system and the rising wealth inequality that this creates.

One of the first lessons I learnt in economics was the concept of diminishing returns.

A point reached in any system, beyond which, adding more actually creates less and eventually, the whole system will break down.

For a look at the distribution of wealth in the world, I suggest the Global Wealth report 2021 published by Credit Suisse here, though don’t jump off before you've read the rest of my missive.

In recent years a new phrase has entered the financial lexicon and that phrase is sustainability. To my mind for a system to be sustainable it needs to be in a state of equilibrium, neither growing nor shrinking but instead being in a state of balance, where inputs and outputs create a predictable and predetermined end result.

Philosophically and personally I think it’s quite likely that sustainability and growth are going to turn out to be incompatible with each other. And that will mean we will have to pick one path or the other. Choosing the sustainable road will require a change of mindset on our part.

Hard as that might be to do I don’t think that it’s impossible. To justify that comment I will refer you to this chart which plots the growth of ETF assets over time.

ETFs are mostly passive. They are not trying to outperform, and instead try to capture the market return for the asset class or strategy they follow, something that I think we can consider being a sustainable or equilibrium approach to investing.

Development of assets in global ETFs from 2003 to 2020: In billions of US dollars

As the chart shows many of us have been happy to follow a passive investment strategy rather than continuously trying to outperform the market (which as we saw last week is almost impossible to achieve over the longer term)

Even when fund managers have achieved that feat, it can be statistically explained away by mathematicians, economists and others.

See the Drunkards Walk by Leonard Mlodinow and in particular his discussion of the Hot Hand Fallacy and the performance of Bill Miller on page 167/ 8 and onwards at the link.

By nature I am a stock picker however I am also a pragmatist and one that likes to take a data-driven approach to the markets.

After all, trading is about slanting the odds in your favour wherever possible and data, stats  and probabilities play a big part in that process.

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This is why a piece of recent research by Bespoke Investment struck such a chord with me.

Despite it effectively being a standard-bearer for passive investing the table below shows us the probabilities of receiving a positive return, over fixed time frames, from investment in the S&P 500 index since 1928.

As you can see there are no periods in which the probability of negative return outweighed those of a positive return and the longer that an investment was left in the market, the greater the probability of a positive return is.

Bespoke then consider the total returns of investors in the S&P 500 over the same timeframes and the same period of observation.

The inclusion of items such as the reinvestment of dividends & share buybacks dramatically increased performance & the probability of a positive return.

To quote the Bespoke analysis:

“When you look at total returns, the rate of positive returns only gets higher.
As shown on the right side of the table, 62.78% of all one-month periods have seen positive total returns for the S&P 500.
At six months, the rate jumps to 71.11%, and at one year the rate is 75%.
On a total return basis, 89.1% of all five-year periods have been positive throughout the S&P's history.”

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However, it gets even more interesting because the sweet spot for returns, the first point at which the probability of a positive return is 100% is found at 16 years

“In the S&P's history, no matter where your starting point has been, all sixteen-year periods have generated positive total returns.”

Quite the stat!

Can we construct a sustainable investment strategy out of this data?

I think the answer is Yes!

Over both the shorter and longer time frames too, as the +82.45% chance of a positive return over two years is not to be sniffed at either.

Trading and investing are different but data like this suggests that for investment purposes at least put a chunk of your portfolio into S&P 500 index tracker and leaving it is likely to be a rewarding strategy.

Also one that will probably give you a lot less heartache and anxiety and as Tim replied to a question in the chat about long term goals:

“Aside from making money, there's got to be some level of enjoyment too. (The) end game is mainly to understand the world better and invest accordingly”

And if your long-term investments are growing then you can afford to do just that with your trading can’t you?

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