Most investors waste a lot of time and money trying to beat the market and achieve double-digit returns by attempting to trade in and out of the hottest stocks. This isn’t a wild accusation. There’s plenty of proof to back up the above claim.
There are three key studies that support this view. All of the studies take different approaches but arrive at the same conclusion… the only way to outperform the market is to invest with a long-term outlook and reinvest your dividends.
Don’t leave it to chance
The first study supporting the above argument looked at the returns of the S&P 500 over six time periods between 1926 and 2015. The six time periods studied were daily, quarterly, one-year, five-year, 10-year, and 20-year. Over this massive 89-year period, the study showed that if you owned the S&P 500 for one day only, you had a 54% chance of a positive return and a 46% chance of a negative return. If you owned the index for a quarter, you had a 68% chance of a positive return and a 32% chance of a negative return.
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Over a five-year holding period, the possibility of a positive return dramatically increased to 86% and over a 10-year holding period the possibility of a positive return rose to 94%.
The most notable figure, however, is the chance of a positive return over a 20-year holding period. If you bought the S&P 500 at any point during the last 89 years and held for 20 years, the data shows that there was a 100% chance of a positive return.
Equity income outperformance
The next study comes from RWC, an independent investment manager established in 2000. RWC runs a simple UK equity income strategy fund, and to show the benefits of such an approach the fund manager published some performance figures at the beginning of last year.
Over a rolling 12-month period, using a simple equity income strategy, an investor would have had a 63% chance of outperforming the wider market according to RWC’s figures. This rises to a 79% chance of beating the market over any rolling five-year period and an impressive 100% chance of outperformance over any 10-year rolling period.
The income component
The reason a buy-and-hold approach outperforms over the long term has a lot to do with the income component of equity returns.
Last year the Brandes Institute published a study analysing public market data as far back as 1926 to evaluate the impact income had on total returns. The main finding of the study was that for overall rolling 20-year periods between 1926 and 2014, dividend income accounted for more than 60% of US equity returns. Over rolling five-year periods dividend income accounted for slightly more than 40% of US equity returns. And over rolling 10-year periods, dividend income accounted for 50% of US equity returns.
Put simply, dividend income accounts for around half of equity returns over the long term. As most indexes don’t reflect dividend income, the buy-and-hold investor is almost certain to outperform over the long term if dividends are reinvested.
