The world of finance and investing is full of wild facts and surprising things that I think investors have to know, because they can help shape our investment behaviours for the better. Here are 24 of them, and their related lessons. This article is a work-in-progress, with additions to be made over time. [Note: The latest additions were made on 11 April 2024]
1. Stocks with fantastic long-term returns can be agonising to own over the short-term.
From 1995 to 2015, the US-listed Monster Beverage topped the charts – its shares produced a total return of 105,000%, turning every $1,000 into more than $1 million. But Monster Beverage’s stock price had also dropped by 50% or more from a peak on four separate occasions.
From 1997 to 2018, the peak-to-trough decline for Amazon in each year ranged from 12.6% to 83.0%, meaning to say that Amazon’s stock price had experienced a double-digit peak-to-trough fall every year. Over the same period, Amazon’s stock price climbed from US$1.96 to US$1,501.97, for an astonishing gain of over 76,000%.
Lesson: Volatility in the stock market is a feature, not a bug.
2. The stock price of a company that deals with commodities can fall hard even if the prices of the related-commodities actually grow.
Gold was worth A$620 per ounce at the end of September 2005. The price of gold climbed by 10% per year for nearly 10 years to reach A$1,550 per ounce on 15 September 2015. An index of gold mining stocks in Australia’s market, the S&P / ASX All Ordinaries Gold Index, fell by 4% per year from 3,372 points to 2,245 in the same timeframe.
In 2015, oil prices started falling off a cliff. The lowest price that WTI Crude reached in 2016 was US$26.61 per barrel, on 11 February. 10 months later on 21 December 2016, the price had doubled to US$53.53. Over the same period, 34 of a collection of 50 Singapore-listed oil & gas companies saw their stock prices fall; the average decline for the 50 companies was 11.9%.
Lesson: The gap between a favourable macroeconomic event and a share’s price movement can be a mile wide.
3. Investors can lose money even if they invest in the best fund.
The decade ended 30 November 2009 saw the US-based CGM Focus Fund climb by 18.2% annually. Sadly, the fund’s investors lost 11% per year over the same period. How?!? CGM Focus Fund’s investors chased performance and bailed at the first whiff of trouble.
Lesson: Timing the market is a fool’s errand.
4. Stock prices are significantly more volatile than the underlying business fundamentals.
Nobel-prize-winning economist Robert Shiller published research in the 1980s that looked at how the US stock market performed from 1871 to 1979. Shiller compared the market’s performance to how it should have rationally performed if investors had hindsight knowledge of how dividends of US stocks changed. The result:
The solid line is the stock market’s actual performance while the dashed line is the rational performance. Although there were violent fluctuations in US stock prices, the fundamentals of American businesses – using dividends as a proxy – was much less volatile.
Lesson: We’ll go crazy if we focus only on stock prices – focus on the underlying business fundamentals instead!
5. John Maynard Keyens was a great economist and professional investor. Interestingly, his early years as a professional investor were dreadful.
Finance professors David Chambers and Elroy Dimson published a paper in 2013 titled John Maynard Keynes, Investment Innovator. It detailed the professional investing career of the late John Maynard Keynes from 1921 to 1946 when he was managing the endowment fund of King’s College at Cambridge University.
Chambers and Dimson described Keynes’ investing style in the early years as “using monetary and economic indicators to market-time his switching between equities, fixed income, and cash.” In other words, Keynes tried to time the market. And he struggled. From August 1922 to August 1929, Keynes’ return lagged the British stock market by a total of 17.2%.
Keynes then decided to switch his investing style. He gave up on trying to time the market and focused on studying businesses. This is how Keynes described his later investing approach:
“As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes.”
Chambers and Dimson’s paper provided more flesh on Keynes’ business-focused investing style. Keynes believed in buying investments based on their “intrinsic value” and that he preferred stocks with high dividend yields. An example: Keynes invested in a South African mining company because he held the management team in high-regard and thought the company’s stock was selling at a 30% discount to his estimate of the firm’s break-up value.
So what was Keynes’ overall record? From 1921 to 1946, Keynes beat the British stock market by eight percentage points per year. When he tried to time the market, he failed miserably; when he started investing based on business fundamentals, he gained stunning success.
Lesson: Invest by looking at stocks as pieces of businesses – it’s an easier route to success.
6. Having extreme intelligence does not guarantee success in investing.
The hedge fund Long Term Capital Management (LTCM) was staffed full of PhDs and even had two Nobel Prize winners, Myron Scholes and Robert Merton, in its ranks. Warren Buffett even said that “If you take the 16 of them [in LTCM], they probably have the highest average IQ of any 16 people working together in one business in the country, including Microsoft or whoever you want to name – so incredible is the amount of intellect.” LTCM opened its doors in February 1994. The firm eventually went bust a few years later. One dollar invested in its fund in February 1994 became just 30 cents by September 1998.
In 2009, Andrew Lo, a finance professor at the Massachusetts Institute of Technology, started his own investment fund in the US. 2009 was the year when many major stock markets around the world bottomed after the global financial crisis started a few years earlier. Lo’s fund gained 15% in 2010, but then lost 2.7% in 2011, 7.7% in 2012, and 8.1% in 2013. The fund was shut in 2014. The S&P 500 in the US nearly doubled from the start of 2009 to the end of 2013.
Larry Swedroe’s book, The Quest for Alpha: The Holy Grail of Investing, described the track record of MENSA’s investment club in the US. MENSA’s members have IQs in the top 2% of the global population. In the 15 years ended 2001, the S&P 500 gained over 15% per year, while MENSA’s US investment club returned just 2.5% per year.
Lesson: Warren Buffett once said, “You don’t need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ.” It’s more important to invest with the right investment framework and have control over our emotions than it is to have extreme intelligence.
7. A stunning number of stocks deliver negative returns over their entire lifetimes.
A 2014 study by JP Morgan showed that 40% of all stocks that were part of the Russell 3000 index in the US since 1980 produced negative returns across their entire lifetimes. JP Morgan defined “lifetime” as the “time when the company first exists in public form and reports a stock price, and until its last reported price in 2014 or until the date at which it was merged, acquired or for some other reason delisted.”
Lesson: Given the large number of stocks that deliver losses to investors, implementing a robust investment framework that helps to filter out potential losers can make a big difference to our investing results.
8. Going against the herd can actually cause physical pain.
Psychology researchers Naomi Eisenberger, Matthew Lieberman, and Kipling Williams once conducted an experiment whereby participants played a computer game while their brains were scanned. The participants were told they were playing the game with two other people when in fact the other two were computers. The computers were programmed to exclude the human participant after a period of three-way play. During the periods of exclusion, the brain scans of the human participants showed activity in the anterior cingulated cortex and the insula. These are the exact areas of our brain that are activated by real physical pain.
Investor James Montier recounted the experiment in his book The Little Book of Behavioral Investing and wrote: “Doing something different from the crowd is the investment equivalent of seeking out social pain.”
Lesson: Investing is not easy, especially when there’s a need to go against the crowd. Make plans to deal with the difficulties.
9. One of Warren Buffett’s best long-term investments looked like a loser in the first few years.
Buffett started buying shares of the Washington Post company (now known as Graham Holdings Company) in 1973 and spent US$11 million in total. By the end of 2007, Buffett’s Washington Post stake had grown by more than 10,000% and was worth US$1.4 billion. By all accounts, Buffet’s Washington Post investment was a smashing success. But here’s the kicker: The Washington Post’s stock price fell by 20% after Buffett’s investment and stayed at that level for three years.
Lesson: Great investments take time to play out. Be patient!
10. It’s easier to make long-term predictions for the stock market than short-term ones.
The two charts above use data on the S&P 500 from 1871 to 2013. They show the returns of the S&P 500 against its starting valuation for holding periods of 1 year (the chart on the left) and 10 years (the chart on the right). The stock market is a coin-toss with a holding period of 1 year: Cheap stocks can fall just as easily as they rise, and the same goes for expensive stocks. But a different picture emerges when the holding period becomes 10 years: Stocks tend to produce higher returns when they are cheap compared to when they are expensive.
Lesson: Invest with a long time horizon because we can make better predictions and thus increase our chances of success.
11. Simple investment strategies often beat complex ones.
Investment manager Ben Carlson wrote in 2017 that the investment performance of US college endowment funds couldn’t beat a simple strategy of investing in low-cost index funds.
For the 10 years ended June 2016, the US college endowment funds with returns that belonged to the top-decile had average annual returns of 5.4%. Carlson described the investment approach of US college endowment funds as such:
“These funds are invested in venture capital, private equity, infrastructure, private real estate, timber, the best hedge funds money can buy; they have access to the best stock and bond fund managers; they use leverage; they invest in complicated derivatives; they use the biggest and most connected consultants…”
In the same 10-year period, a simple portfolio that Carlson named the Bogle Model (after the late index fund legend John Bogle) produced an annual return of 6.0%. The Bogle Model consisted of three, simple, low-cost Vanguard funds: The Total US Stock Market Index Fund (a fund that tracks the US stock market), the Total International Stock Market Index Fund (a fund that tracks stocks outside of the US), and the Total Bond Market Index Fund (a fund that tracks bonds). The Bogle Model held the three funds in weightings of 40%, 20%, and 40%, respectively.
Lesson: Simple investing strategies can be really effective too. Don’t fall for a complex strategy simply because it is complex.
Note: An earlier version of this article was published at The Smart Investor, an investing website run by my friends.
The fact below was added on 5 December 2019
12. Buying and holding beats frequent trading.
Jeremy Siegel is a finance professor from Wharton, University of Pennsylvania and the author of several great books on investing. In 2005, he published a book, The Future For Investors. Wharton interviewed him to discuss the research for the book, and Siegel shared an amazing statistic (emphasis is mine):
“If you bought the original S&P 500 stocks, and held them until today—simple buy and hold, reinvesting dividends—you outpaced the S&P 500 index itself, which adds about 20 new stocks every year and has added almost 1,000 new stocks since its inception in 1957.”
The S&P 500 is not a static index. Many stocks have been added to it while many stocks have also removed. So, we can also see the S&P 500 as a ‘portfolio’ of stocks that have experienced very active buying and selling. What Siegel discovered was that over a period of nearly 50 years, a long-term buy-and-hold ‘portfolio’ of the original S&P 500 stocks would have outperformed the actual S&P 500 index that had seen all that relatively frantic ‘trading’ activity.
Lesson: Active trading is bad for our returns. To do well in investing, patience is an important ingredient.
The facts below were added on 8 January 2020
13. It’s incredibly difficult to make money by trading currencies.
The Autorité des Marchés Financiers (AMF) is the financial regulator in France – think of them as the French version of the Monetary Authority of Singapore. In 2014, the AMF published a study on individual forex traders. It looked at the results of 14,799 individual forex traders for a four-year observation period from 2009 to 2012 and found some astonishing data:
- 89% of the traders lost money
- The average loss was €10,887 per trader
- The total loss for the nearly 15,000 traders was more than €161 million
Lesson: Trading currencies could be a faster way to lose money than lighting your cash on fire.
14. Historically, the longer you hold your stocks, the lower your chances of losing money.
Based on data for the US stock market from 1871 to 2012 that was analysed by Morgan Housel, if you hold stocks for two months, you have a 60% chance of making a profit. Stretch the holding period to 1 year, and you have a 68% chance of earning a positive return. Make the holding period 20 years, and there’s a 100% chance of making a gain. The chart below, from Morgan, illustrates these:
Lesson: Time in the market is your best ally.
The fact below was added on 19 January 2020
15. Huge moves in stocks that should not have happened, according to mainstream finance theories, have happened.
In 12 August 2019, Argentina’s key stock market benchmark, the Merval Index, fell by a stunning 48% in US-dollar terms. That’s a 48% fall. In. One. Day.
According to investor Charlie Bilello, the decline was a “20+- sigma event.” Mainstream finance theories are built on the assumption that price-movements in the financial markets follow a normal distribution. Under this framework, the 48% one-day collapse in the Merval Index should only happen once every 145,300,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000 years.
For perspective, the age of the universe is estimated to be 13.77 billion years, or 13,770,000,000 years.
Lesson: The movement of prices in the financial markets are significantly wilder than what the theories assume. How then can we protect ourselves? Bilello said it best: “We must learn to expect the unexpected and be prepared for multiple outcomes, with diversification serving as our best defense.”
The facts below were added on 31 January 2020
16. Timing the market based on recessions simply does not work.
In an October 2019 blog post, investor Michael Batnick included the following chart:
The red line shows the growth of $1 from 1980 to late 2019 if we bought US stocks at the official end-date of recessions, and sold stocks at the official start-dates. A $1 investment became $31.52, which equates to an annual return of 9.3%. That’s not too shabby.
But if we had simply bought and held US stocks over the same period, our dollar would have grown by 11.8% per year to become $78.31. That’s a significantly higher return.
Lesson: Trying to side-step recessions can end up harming our returns, so it’s far better to stay invested and accept that recessions are par for the course when it comes to investing.
17. The market is seldom average.
Data from Robert Shiller show that the S&P 500 had grown by 6.9% per year (after inflation and including dividends) from 1871 to 2019. But amazingly, in those 148 years, only 28 of those years showed a return of between 0% and 10%. There were in fact 74 years that had a double-digit gain, and 23 years with a double-digit decline.
The chart below shows the frequency of calendar-year returns for the S&P 500 from 1871 to 2019:
Lesson: Market returns are rarely average, so don’t expect to earn an average return in any given year. Don’t be surprised too and get out of the market even if there has been a big return in a year.
The facts below were added on 11 February 2020
18. An entire country’s stock market can go crazy.
The stock market’s a great place to build wealth over the long run. Data from the Credit Suisse Global Investment Returns Yearbook 2019 report show that developed economy stocks have generated a return of 8.2% per year from 1900 to 2018 – this turns $1,000 into $10.9 million. Meanwhile, stocks from emerging markets have climbed by 7.2% per year from 1900 to 2018, turning $1,000 into $3.7 million.
But there’s also the case of Japan. The country’s main stock market benchmark, the Nikkei 225 Index, hit a peak of nearly 39,000 in December 1989, more than 30 years ago. It sits below 24,000 today, a decline of around 40% from the high point in December 1989.
The reason Japanese stocks have delivered this poor return over such a long period of time is because they had crazy-high valuations. Investor Mebane Faber pointed out in a blog post a few years ago that Japan’s stock market had a CAPE ratio of nearly 100 at the peak. The CAPE ratio – or cyclically-adjusted price-to-earnings ratio – is calculated by dividing a stock’s price with its average inflation-adjusted earnings over the past 10 years.
For context, the US stock market’s highest CAPE ratio since the 1870s was 44, which was reached in December 1999, at the height of the dotcom bubble. From the 1870s to today, the average CAPE ratio for US stocks is just 17.
Lesson: The entire Japanese stock market went crazy in the late 1980s, resulting in a disastrous return for investors even after more than 30 years. The experience of Japan’s stock market is also a great reminder that we should diversify our investments geographically.
19. Some of the best investors in the world don’t know what the stock market will do over the short-term.
What do Peter Lynch, Warren Buffett, and Jim Simmons have in common? They all would easily belong to any “Greatest Investors” list.
Lynch was the manager of the US-focused Fidelity Magellan Fund from 1977 to 1990. During his 13-year tenure, he produced an annual return of 29%, nearly double that of the S&P 500. Meanwhile, Buffett has been in control of his investment conglomerate, Berkshire Hathaway, since 1965. From then to 2018, he grew the book value per share of Berkshire by 18.7% per year by using its capital to invest in stocks and acquire companies. Over the same period, the S&P 500 compounded at merely 9.7% annually. As for Simmons, he runs Renaissance Technologies, an investment firm he founded. Renaissance’s flagship is Medallion Fund, which generated an astonishing annual return of 66% (before fees) and 39% (net of fees) from 1988 to 2018.
There’s another thing that Lynch, Buffett, and Simmons all have in common: They have no clue what the stock market will do over the short-term.
In an old interview with PBS, Lynch said:
“What the market’s going to do in one or two years, you don’t know. Time is on your side in the stock market. It’s on your side. And when stocks go down, if you’ve got the money, you don’t worry about it and you’re putting more in, you shouldn’t worry about it. You should worry what are stocks going to be 10 years from now, 20 years from now, 30 years from now.”
Buffett wrote a famous op-ed for The New York Times in October 2008, at the height of the Great Financial Crisis. In it, Buffett shared:
“Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month or a year from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.”
There’s an incredible story on Simmons panicking in December 2018, after the US stock market had suffered a steep drawdown. Simmons asked his financial advisor if he should be selling short, literally a day before the US market reached the trough of its decline.
It’s easy for us to think that investing masters like Peter Lynch, Warren Buffett and Jim Simmons will be great at predicting what the stock market is going to do over the short run. But the truth is, they don’t. They have no idea.
Lesson: We can still achieve great long-term investing results even if we have no idea what the market’s going to do over the short run.
The facts below were added on 23 March 2020
20. Recessions and market crashes are inevitable
Economist Hyman Minsky passed away in 1996. When he was alive, his ideas were not well-known. But they gained widespread attention after the Great Financial Crisis of 2007-09.
That’s because Minsky had a framework for understanding why economies go through inevitable boom-bust cycles: Stability itself is the seed of instability. When an economy is stable and growing, people feel safe. This feeling of safety leads to people taking on more risk, such as borrowing heavily. The system in turn becomes fragile.
Minsky’s idea can be applied to stocks too. Let’s assume that stocks are guaranteed to grow by 9% per year. What will this world look like? The only logical result would be that people would keep paying up for stocks, till the point that stocks become way too expensive to return 9% a year. Or people will pile on risk, such as borrowing heavily to buy stocks.
But bad things happen in the real world and they happen often. And when stocks are priced for perfection, bad news will lead to market crashes.
Despite the inevitability of recessions and market crashes, stocks have still done very well over time. Between 1928 and 2013, the S&P 500 had, on average, fallen by 10% once every 11 months; 20% every two years; 30% every decade; and 50% two to three times per century. So stocks have declined regularly. But over the same period, the S&P 500 also climbed by 283,282% in all (including dividends), or 9.8% per year.
Lesson: Recessions and market crashes are a feature of the financial markets, not a bug. We can still do very well over the long run by just holding onto stocks through thick and thin.
21. Volatility clusters – and its important implication
Volatility has been the name of the game for the financial markets in recent times. This is what the S&P 500 in the US has done over the past two weeks:
- 9 March 2020: -7.6%
- 10 March 2020: +4.9%
- 11 March 2020: -4.9%
- 12 March 2020: -9.5%
- 13 March 2020: +9.3%
- 16 March 2020: -12.0%
- 17 March 2020: +6.0%
- 18 March 2020: -5.2%
- 19 March 2020: +0.5%
- 20 March 2020: -4.3%
We can see that really good days are mixed together with really bad days. This clustering of volatility is actually common. Investor Ben Carlson produced the table below recently (before March 2020) which illustrates the phenomenon.
The clustering means that it’s practically impossible to side-step the bad days in stocks and capture only the good days. This is important information for us, because missing just a handful of the market’s best days will destroy our returns.
Fund manager, Dimensional Fund Advisors, which manages more than US$600 billion, shared the following stats in a recent article:
- $1,000 invested in US stocks in 1970 would become $138,908 by August 2019
- Miss just the 25 best days in the market, and the $1,000 would grow to just $32,763
Lesson: It is important that we stay invested. But this does not mean we should stay invested blindly. Companies that currently are heavily in debt, and/or have shaky cash flows and weak revenue streams are at much higher risk of running into severe problems, whether the economy is healthy or in trouble. It’s good practice to constantly evaluate the companies in our portfolios.
The facts below were added on 17 October 2022
22. Rising interest rates have been met with rising valuations
There’s plenty of attention being paid to interest rates because of its theoretical link with stock prices. Stocks and other asset classes (bonds, cash, real estate etc.) are constantly competing for capital. In theory, when interest rates are high, the valuation of stocks should be low, since bonds, being an alternative to stocks, are providing a good return. On the other hand, when interest rates are low, the valuation of stocks should be high, since the alternative – again, bonds – are providing a poor return.
But the real relationship between interest rates and stock market valuations is nowhere near as clean as what’s described in theory. Yale economist Robert Shiller, who won a Nobel Prize in 2013, has a database on interest rates and stock market prices, earnings, and valuations going back to the 1870s. According to his data, the US 10-year Treasury yield was 2.3% at the start of 1950. By September 1981, it had risen to 15.3%, the highest rate recorded in Shiller’s dataset. In that same period, the S&P 500’s price-to-earnings (P/E) ratio moved from 7 to… 8. That’s right, the P/E ratio for the S&P 500, a broad-based US stock market index, increased slightly despite the huge jump in interest rates.
(It’s worth noting too that the S&P 500’s P/E ratio of 7 at the start of 1950 was not a result of earnings that were temporarily inflated.)
Yes, I’m cherry picking with the dates for the second point. For example, if I had chosen January 1946 as the starting point, when the US 10-year Treasury yield was 2.2% and the P/E ratio for the S&P 500 was 19, then the theoretical relationship between interest rates and stock market valuations would appear to hold up nicely.
Lesson: Interest rates have a role to play in the movement of stocks, but it is far from the only thing that matters. Moreover, one-factor analysis in finance – “if A happens, then B will occur” – should be largely avoided because clear-cut relationships are rarely seen.
23. Peak valuations for stocks don’t happen at the lowest interest rates
In Point 22 above, I mentioned that “the real relationship between interest rates and stock market valuations is nowhere near as clean as what’s described in theory [where the theory is that rising rates will lead to falling valuations].” The chart below, which I first saw from a Twitter user with the handle @modestproposal, is a great example.
It illustrates the relationship that the S&P 500’s price-to-earnings (P/E) ratio has with 10-year bond yields in the USA. Interestingly, the S&P 500’s P/E ratio has historically and – noticeably – peaked when the 10-year bond yield was around 5%, and not when the 10-year bond yield was materially lower at say 3% or 2%.
Lesson: Don’t assume that peak valuations for stocks must happen at the lowest interest rates.
The fact below was added on 11 April 2024
24. Buying stocks at all-time highs leads to higher returns than buying stocks at random timings
Intuitively, it makes sense that investing in stocks when they are at all-time highs should lead to poorer returns than if you were to invest in stocks at any random day. But history suggests otherwise. According to Ritholtz Wealth Management (link leads to a video; watch from 38:00 mark), the average annualised return for the S&P 500 since 1970 for someone investing at all-time highs has been 9.43% for one year, 10.53% for three years, and 9.63% for five years. Meanwhile, the average annualised return for the self-same periods for someone investing at any day would be 9.13%, 8.85%, and 8.93%, respectively. These are shown in the chart below:
Lesson: Do not stay away from stocks just because they are at all-time highs – time in the market is way more important than timing the market
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