Index Funds vs. Stocks in 2021 (The Facts Driving Future Returns - Passive vs Dividend)

good day fellow investors today we're going to talk about strategy index funds versus stock picking because string theory down below asked okay sven you talk a lot risks reward crashes investing long term what's the difference between index funds and stock picking because harry said that blah blah blah yes the dow will be at 50 000 points in 2025 and i answered possible also 60 000 points so i really believe that the s p 500 can double by 20 30. so 8 000 points which means both strategies are good index funds good and stock picking good because both strategies are positive some long-term investing strategies which is key when it comes to building wealth over the long term and what i'm going to explain in this video are the key drivers for investing returns what's the difference between index funds and stock picking so that you can pick what is best for you you know yourself you need to have the data which will go through and then you can make the right decision what's best for me the key when it comes to investing in life is finding your investment vehicle there are plenty of good investment vehicles and if you pick among those you'll do well in life that's the key if this video gives you an answer and value please click that like button because it helps with the youtube algorithm and if you want to learn more about the investment mindset on this channel please consider subscribing let's start with just a notion of putting things in perspective 2021 we have a bad economy and plenty of money just a quick recent news the dutch national bank said how dutch people added 487 billion euros to their saving account accounts just sitting there on the saving account which means that if i divide by 17.2 million people on average every dutch person has 28 000 sitting on his bank account doing nothing so that's the average over the whole country and getting zero which means people are looking for things to do with that money and the consequences is pretty simple we have had zero interest rates for longer and the sap 500 over the last 11 years is up 450 440 from 600 something points to the current 3714 points if we look at the german index also significantly up what is this four times three times since the financial crisis more money low interest rates and stocks go higher higher and higher and also the dividend yield for the sap 500 is just 1.55 and for the tax index is 2.22 interest rates are zero or in some countries depending on how much money you have negative so in this environment is it still smart to invest in index funds okay dividend yields of 2 are still better than 0 in the bank but also we know stocks are volatile and stocks goes go up and down as we have seen in the chart so we have to explain what are the drivers for index fund returns and then for individual stock returns and then again you'll see what's the best answer for you and i also share my answer for me what's the best for me if we look at morgan stanley's projection for long-term investing returns nominal investing returns over the next 10 years we have the sap 500 at 6.3 per year we have european stocks and 9.3 which is significantly higher than the s p 500 we have seen also the higher dividend in germany respective to the sap 500 japan 7 emerging markets six percent bonds one point four percent very very bad and also high yield very risky junk bonds just two point five percent which is much lower than the historical averages except for stocks that are still there in line we'll explain now what drives these returns there are three components that drive investment returns is the price you pay versus what you get so versus the earnings the value that the business you own when you buy it delivers to you in that moment then you are buying a dynamic entity that grows hopefully in the future thus you have organic growth and businesses if they can increase prices also protect you from inflation so that is the true factor of investing returns if we take a look at sap 500 earnings these are the forecasted earnings for the next 12 months and those earnings are always a little bit exuberant and we have the sap 500 earnings now forecasted to be next year 170 points but forecasts are always a little bit too exuberant let's take reality so here we have this is from macro trends and sap 500 earnings if you want to find this chart here we have the real earnings over time the orange line so earnings were around 90 then trump lowered taxes so earnings jumped significantly and we are now or we have been in 2019 at 140 points now we have a crisis so earnings are lower but as we recover from the crisis earnings will likely be again around 140 points and then continue growing at the standard earnings growth rate if i put this into a current earnings versus price perspective sap 500 3714 points earnings 140 price to earnings ratio dividing 3 700 with 140 is 26 and if i look at the earnings yield 100 divided by 26 i get an earnings yield of 3.77 that is the earnings that on average businesses from the sap 500 deliver per year to the shareholder okay that is much better than the zero or the 0.5 or the one percent that you could get in a bank or bonds so why are stocks giving a higher return that's because academically speaking because of the risk premium and recently the model run if there is one youtube channel that i recommend subscribing for great learning purposes educational purposes that is ashwath damodaran from the new york stern school of business so check out his channel too and also he says that there is a risk premium because stocks are considered more risky than let's say a bond or a bank account and the risk premium is the difference between a five or a ten year bond and the earnings rate or the expected returns for the sap 500 now we are around five percent when we had growth inflation but the earnings premium was close to eight percent in the 2020 march lows when everybody was afraid about the covet crisis and historically we are now at an even historical risk premium so what is the added value from stocks we are now at what five percent and historically it has been always around four four five four percent so stocks because of their volatility give or people require a higher risk in comparison to where there is let's say no risk like bonds or bank accounts but there is one key difference in returns if the returns on bonds are zero or one percent and then you add the risk premium you still get to a long term return of 5.65 which is much lower than what was the long-term return and what people expect from stocks over time yes over the last 60 years it was 10 now we are at 6 and this is something very very important the other two components of your investment returns are the growth of the earnings in the future and also inflation if we again look at the earnings those over time grow and if we look at historical earnings over 30 years the sap 500 earnings went from 20 points 30 years ago to the current 140 points if i divide 140 divided by 20 that's seven times up and then over 30 years that's approximately six percent earnings growth over time historically let's say that 1920s it was one we are now in 140 140 divided by one of course it's one if we try to take it a hundred years what's the yearly return over 100 years it's around five percent and it's the average sometimes it's slower sometimes is faster five percent earnings growth five percent earnings growth over time adds to stock market investing returns so if we add let's say organic growth 2 inflation average inflation long term 3 percent we get to a total sap 500 return from current position of 8.77 of course this depends on inflation because if inflation is just 1 not 3 then the return is 6.77 there are recessions slower growth etc etc but that is for another story then also if you own the sap 500 you own amazing companies apple microsoft amazon facebook amazing tesla of course alphabet berkshire j j so companies that will likely be around for the next 50 years at least most of them grow their earnings and deliver what is the historical return for investing in stocks which again from the modern or schiller nine percent nine point seven percent depending on what's the time frame you look at but stocks have delivered around eight to ten percent long-term nominal returns which means that one dollar in 1900 till now would be 58 000 however keep in mind the difference in inflation which is average three percent per year one dollar in real purchasing power with bonds gives you nothing ten dollars but still two thousand dollars this is three percent of nominal returns the difference between this and this is inflation if you own businesses you are long-term let's say protected from inflation so you might think sven you're now saying that the sap 500 even at this bubble times will return 8 per year 8 depending also on inflation six percent is more likely but still these are historical averages depending on inflation on the economy on the growth rate and let's compare now with stocks but also then also we'll discuss later the risks of investing in index funds what can go wrong and jeopardize your investment let's say retirement plans and let's talk also about stocks let me give an example of what are stocks compared to index funds so in a recent video i discussed grocery stocks one of them is kroger when i discussed is the price earnings ratio was about 15 so that is already much better than the price earnings of the sap 500 so stock this is the return if the growth as it's a grocer is just one percent and equal growth on inflation with kroger stocks i get to 10.5 percent which is still higher than the sap 500 not much but significant and if you can get 20 stocks like this then you will have diversified your risk and you should have a long long-term higher return than the s p 500 that's my reasoning for investing in stocks of course investing in stocks requires work because you have to analyze the companies know what's going on and you have to see whether investing in stocks is worth it or not for you the differences are significant but maybe you just focus on doing what you know how to do your job your business and invest the money automatically in index funds that's a big advantage of index funds let's check the difference this is investor government compound interest calculator let's start with 10 000 today let's say we add 1000 to our investment per month let's say we invest for 20 years is interest rate we said let's say stocks 10 and interest variance rate let's say sap 508 percent so i put 2 here and now i calculate and the results are that in 20 years with 10 and investing 1000 per month i'll have 754 000 let's compare this with two percent less which is the variance here below and you can see that the difference is approximately 150 000 so 754 thousand with 10 if you get 12 you are again higher and i am targeting this difference the variance above of 12 versus the variance below of what the index fund will likely get me that's doubling my money over 20 years over 40 years so this is the reason why i invest in stocks but keep in mind that the variance below the s p 500 is still great and especially for not thinking as i said it is a positive sum game you just have to see what's best for you and another thing that might put things into perspective a little bit we discussed how the is scp-500 a bubble stocks are in a bubble especially tech stocks with no valuation neo for example that i discussed in a video on friday but let's put things into perspective the sap 500 dividend is 1.5 and it has been low for the last two decades but in history the s p 500 dividend was on average four percent with even spikes to seven eight percent this is really incredible compared to what we have now so let's put things into a dividend perspective because dividends is what you're going to eat 10 20 years down the road stocks will go up and down but dividends is what will be the steady deliverance for your investment returns and if we invest in the sap 500 yes dividends will be double in 10 years so if you invest a million now you will get dividends of 15 000 likely over a year if those dividends grow that will be 30 000 on the million invested in 2030 60 000 in 2040 and then you have to see okay if i put my money there i get sixty thousand per year likely in twenty forty forty thousand in twenty thirty how does that fit my other options if i put a million in a home rental with all the costs and everything do i get more than 30 000 per year in 2030 so if we look at sap 500 dividends over the last decade the dividend was 25 points 10 years ago and now we are at 57 points for the 1.5 yield this is from sap 500 dow jones indices dividend points index but let's look a little bit at the risks i have this intrinsic value template you can download it directly in the link in the description below of this video and i have put the dividend of the sap 500 and i have put that it grows at 5 per year over the next 10 years i have set a discount rate of 5 and let's say that we need a 2 dividend yield 100 divided by 2 is 50 terminal multiple in 20 30 and the intrinsic value of the sap 500 for a 5 discount rate is 3284 points if we stick to the 1.5 dividend yield it's still a little bit undervalued so long-term returns you have the basis that safe it's the dividend and i think it will double in 2030. but the question for your long-term returns and the key thinking when it comes to index funds are you basing your whole retirement strategies on the premise that stocks will go up that's the key question to see whether you're okay with that or not because if the dividend changes the required dividend changes if we have higher interest rates than we have had the last 10 years if the required dividend yield goes to 4 for the sap 500 which has been the historical average then things might also change from that stocks always go out up perspective just let's put here a terminal multiple of 4 dividend yield then the sap 500 in 2030 will be just 2 20 points which means a decline of 33 for a current intrinsic value of 2 000 points which shows that in this case indexes are in a bubble if we return to the historical averages for dividend yields and interest rates interest rates always go up and down so mean reversion will happen at some point in time and if that happens and hits the s p 500 then a lot of those that think that stocks always go up might be very unpleasantly surprised from that stock go up perspective but from another perspective you are now reinvesting at the four percent dividend yield which will increase your long-term returns much better if you're a long-term investor 10 20 years you have to hope that your holdings go down 50 60 70 now because by buying them at a lower price you increase the long-term returns so it is counter-intuitive but if stocks go lower you should be happier not the other way around because if those go up the reinvested dividend leads to lower returns and if those require dividends changes then this can happen 25 years of zero returns nine years of zero returns 12 years of zero returns if the expectations are not met or if the dividend required yield changes as it was the case in the 1970s and this is inflation included if we look at inflation-adjusted returns for the sap 500 since the peak in 1968 it took what is this 25 years to get back to zero and people think this was a tragedy but actually for real investor this was a blessing because those kept buying at these lows like buffett and had amazing returns from here where nobody wanted to touch stocks to here when everybody was exuberant about stocks we are now again in exuberant times and as you can see everybody is extremely bullish on u.s stocks now that's the big weight we'll be looking at germany and emerging markets over the coming months my intern will look at germany so you can expect more videos and then you can compare you can see what's better for you long-term risks of course if we look at long-term investment returns over the last 120 years we have u.s that did almost 10 which is great on average the world 8 europe 7 so business return four percent inflation three percent and you have these returns now with now the expectations are that the s p 500 will deliver from this point six percent which is still good but should now one invest in stocks or not well that also depends on the kind of stocks you are investing in if we look at jim cramer's 2000 stock picks you see how all those did terribly and it was better for the investor to invest in index funds let's say at that time so it's also about picking the right stock and if we look a little bit at examples this is my valuation of neo and it's really exuberant things have to happen for a car company to pay dividends grow 15 or more and have a terminal multiple price earnings ratio of 50 that's very exuberant if things return to the normal in the car industry neo stock price will be much much lower let's take a look at kroger we can expect a 7 8 return at the current stock price i think it went higher since i made the analysis but much more reasonable growth rates terminal multiple of just 15 on the cash flow also if you want to be a value investor this is from my book modern value investing and you see how yes sometimes growth outperforms value but over the years on average five percent higher yearly returns from value investing than from what's called growth investing then there we can debate a lot what's growth i don't agree with this value investing definition i think value investing is about the future not about pest metrics but that's again questioning how deep do you want to go into investing also some countries over 50 years delivered negative investment returns it also depends on what's the starting point some countries did really really good and here is the key i think for everything whatever you decide what will be your long-term investing strategy there is always the key risk is you what will you do when things don't go as planned and when it comes to investing that's why you have that risk premium things often don't go as planned benjamin graham the author of the intelligent investor said that investors chief problem and even his worst enemy is likely to be himself and if we look at j.p morgan's 20-year returns we have here the s p 500 with 6 annualized returns but the average investor brought home 2.5 perhaps they are betting too much on stocks crazy stocks like neo or things like that and on the long term it delivers very bad returns so it's up to you whether you want to accumulate wealth over time you when something goes down you buy more you're happy for that and then you achieve 6.5 or even more if you sell in fear when stocks are down like many did in 2009 and buying greed at unprecedented stock market highs because now stocks are the only option so attractive here nobody wanted to touch stocks nobody wanted to when i started investing in 2002 everybody said oh your crazy stocks everybody lost a lot of money on stocks because of this the dot com bubble then in 2009 stocks stay away from stocks whoa whoa because of the financial crisis now everybody's into stocks because there is no other option and that's again a risk about stocks everybody's buying today and that tells you historically from a behavioral investing perspective that there is a high risk and now you have to decide what's best for you index funds 5 6 10 depending on what happens in the market inflation the required dividend yield and also the low dividend that is there now that will be the determines of index fund investing but low cost and you don't have to think about it the key is also to compare the returns there to other options in your life if you have a credit card interest rate of 13 or a student loan of seven then compared to the current six percent seven percent of index fund with the volatility you pay off the student loan if you have a mortgage of 2 fixed for long term and you have stocks that will lead 5 without thinking then you also have your answer when it comes to stocks and this is my personal preference because i decide what do i want to own of course good companies but apple we made a video overvalued tesla no comment so i don't want to own apple now i don't want to own tesla now and that's what i don't like about index funds tesla just entered an index fund and yes it did good since it entered the index fund but the index fund didn't buy here it's buys here when the stock is already up 10 times or even more from the ipo if i wanted to own tesla i could have bought it here for myself and then accept the risk reward index fund have to include it because the market capitalization is huge and the key driver of index fund investment is the market capitalization that's something i don't like i prefer to decide by myself what i want to own plus i want to decide and look at the top 10 sap 500 components for 2000. so general electric debt wasn't something that ended well with the 500 billion market capitalization x and mobile also did not end really well citigroup went bust cisco recovered a little bit walmart did well but not spectacularly aig went bust so you don't have a choice on what you want to own it all depends on what the market thinks on the market capitalization and then of course the bubble burst so you don't have control over that personally i have a passion for owning businesses i have a passion for constantly comparing what are the real dividend earnings returns over time no matter what the market expects i want to get my dividends i compare them to the s p 500 if the s p 500 would now be at 1 000 points this channel would be called index fund investing with sven kathleen all else equal and i would make five videos a day screaming to people by index funds at one thousand points it's four thousand points and i just simply like to use common sense but it requires also effort so i'm not saying nothing bad about index funds i'm just saying it depends on you as i said possible down 50 okay the dividend yield will still be three percent but let's say i own something that is okay going down fifty percent and then the dividend goes from the current six to twelve percent this six percent ten percent yield compared to the three percent is what will make a huge difference long term because yes stocks can go up for longer but the higher those go the lower is your long-term return and i firmly believe that if if you have an active common sense investing mindset then you are open to hitting the jackpot a few times in your life if you just think okay automatic sap 500 index fund and that's it you don't even spend half an hour thinking of what you are buying and why then you will miss on what charlie munger says that you only need three great investments in your life the key is that you have to recognize that in those investments and perhaps the s p 500 will do eight percent perhaps we'll do eight percent over the next 10 years and then in 2031 the sap 500 will still do 8 but by looking and everything will recognize the great investment and do 100 in one year because all the indications of value investing will be there and that will make a whole difference because it will lead to double the investment returns over time and that's why i put so much effort into investing education it has worked enormously well for me if i would have put only my money in index funds in 2002 i would have made five times my money i have made 20 times so that's the difference also 2013 i was looking around the houses in the netherlands were cheap and we did everything we could to buy index fund investing would be buy whenever no matter what and that's a huge difference that leads to okay in life but i prefer always to strive for the one percent that do great in life that's my opinion i hope i have given you the risk and rewards for everything and you can make your own educated decision now if you like this click that like button looking forward to your comments and i'll see you in the next video

Channel: Value Investing with Sven Carlin, Ph.D.

Views: 51,688

Rating: 4.96876 out of 5

Keywords: index funds, etfs, index funds investing, index funds or stocks, index funds vs stocks, s&P 500, vanguard index funds, vanguard, best index funds, stock market, stocks, how to invest in stocks, how to invest in index funds, index funds for beginners, investing in index funds

Id: iblGIbS3Pqc

Length: 30min 15sec (1815 seconds)

Published: Sun Jan 31 2021