Introduction
The SPDR S&P 500 ETF (Ticker: SPY) is an exchange-traded fund designed to trade in tandem with the S&P 500 index. SPY’s tracking error of 0.04 indicates this ETF does a good job about following the movements of the index it is designed to mimic. You can acquire shares of SPY through your brokerage account easily by searching for SPY and submitting a buy order. There are similar ETF’s your broker might offer at a reduced or $0 commission but for the purposes of this return analysis we will be using historical values from SPY.
With data dating back to January 1, 1993 to September 1, 2019 the average monthly return is 0.84% with a standard deviation of 4.15%. Assuming SPY’s returns are normally distributed, there is a 95% chance that you get a monthly return of -7.46% to +9.14%.
Monte Carlo
After running a Monte Carlo simulation I found that if you were to invest $500 a month in SPY for 30 years you will have contributed a total of $180,000. After 100 iterations of this simulation, your average wealth after 360 months have elapsed would be $1,146,241.65. Putting the 100 iterations on a distribution reveals that you have a 95% chance of ending with -$364,739.76 to +$2,657,223.06. Being that you can’t actually have a negative balance in stocks it would be fair to assume the lowest your ending balance could go is $0. This spread also demonstrates the S&P’s reliability to go up over time as you have a good chance of getting far more than the average of $1.1 million.
To bring perspective to this simulation all you have to do is answer one question. U.S. GDP is roughly $60,000 a year which would be $1.8 million over 30 years assuming no raises, which is unlikely. Would you invest 10% of your income over 30 years to be able to get more than 10 times your principal investment of $180,000? I hope your answer is yes, especially since as we get older our income generally goes up and the percentage of our wealth we have to give up would steadily go down.
Recession Worries
Recently there have been murmurs of a looming recession, to better understand the probability lets take a look at the Great Recession of 2008. SPY’s poorest performance was from 9/30/2008 to 10/31/2008 where shares dropped by a whopping 16.04%. So what are the odds we have a down day of this size again? With an average monthly return of 0.84% and a standard deviation of 4.15% there would be a 0.0000239% chance of losing 16.04% in a month. This is further evidence that fears of a looming recession should play no part in investing in the S&P 500. It should be noted that fat tail risk may exist. This is where the probability of a drastic situation in the tails of a distribution may actually be more likely than something less drastic that being said even if the odds of a -16.04% month were 100% more than I estimated it would still be almost entirely improbable.
Recommendation
I recommend investors buy SPY at any point in time as long as their time horizon exceeds 10 years. If we do have a recession coming soon and the market drops that would be a great time to buy even more SPY to extend your profit margin. This is the tried and true “passive investing” strategy that people have trusted for decades.