Which Investment Style Leads to the Highest Return Historically?

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wall street bull

wall street (2)There are many ways to play the stock market. You can play the stock market safely by simply buying index stocks. In other words, your investment portfolio would mirror the Dow Jones Industrial Average or the S&P 500.

 

This means that as the S&P matures and appreciates along with the US economy, your portfolio matures as well. There’s very little research needed. You just buy the fund and just let it ride. Your only investment is time. You need to have a long time cycle. Moreover, if you retire or need the money during a historical period where the stock market is going through a rough time, I am of course talking about the 1970s, you’re going to probably walk away with a loss depending on when you enter the market.

 

With that said, long-term plays pay out really well over the long haul. According to a recent study by Dimensional Fund Advisors based on compound rate of return, the years 1928 to 2014 produced very interesting results depending on your investment style. If you are simply trading large caps in the S&P 500, a $100 investment in 1928 will now be worth $346,261. This is an 87-year compound rate of return average of 9.8% return.

 

However, it’s worth noting that if you look at the numbers on a year by year basis, this is not an even return. The best return you would get is 54%. The worst return within a year is a negative return of 43%. In other words, the fund shrunk by 43%.

 

The best performer, however, would be a small-cap value stock. If you don’t want to just put your money on the stock market, let it ride, and follow the index but actually want to pick smaller cap companies as they grow, your $100 invested in 1928 would now be worth $6,563,730. That means very single year, your investment grew by 13.6%. On a year to year breakdown, your best year would have been a 125% increase while your worst year would have been a negative 54% shrinkage.

 

What does this tell us? All it tells us really is if you want to really grow your money, you have to manage it well, and you have to take a lot of risks. Simply letting it ride on the index will produce a return, but it may not be the return that you want especially if you’re going to be retiring in the future and there might be runaway inflation in the future. The best approach would be actively managing your portfolio to focus on growing companies.

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