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The S&P 500 averaged an annual return of 11.82% return since it’s inception.1
If you search on how to invest, the most likely advice that you will get is to just buy index funds.
From 2009-2021 the S&P averaged almost 16% per year!!
💭What are index funds?
An index is a group of companies that represents the stock market. One of the most popular index is the S&P 500. This comprises of top 500 publicly listed companies in the US.
In the Philippines, it’s the PSEI (Philippine Stock Exchange Index). It comprises of the top 30 publicly listed companies in the Philippines.
An index fund then is a fund (usually an ETF or mutual fund) that invest and tracks the stocks of an index. They just “buy and hold” the stocks that consists of the index. 2
In contrast, active funds are ETFs or mutual funds that trades stocks. They actively buy and sell stocks within that fund “ to beat the market”.
If indexing is just passively buying and holding, shouldn’t you just buy the stocks yourself?
The problem with doing that is it will cost a lot of money to buy the individual stocks. Also it is hard to keep track of all the individual stocks if you try to mimic an index.
So one of the advantages of buying index funds is that they provide you a broad exposure to the stock market at very low cost.
In the Philippines, the rise of mutual funds and UITFs made buying passive-index funds accessible. I believe you can invest in these index funds for as low as P1,000.00
🚀The Rise of Passive Investing
Passive investing became popular IMO because of the following :
Stock picking is hard.
S&P historically had an amazing past performance based on returns.
Before passive-investing became popular, stock picking was the way to invest. But it is hard to consistently beat the market. Even the experts failed to do so:
Beating the market means having a higher return than the index or S&P 500. For the Philippines, beating the market meaning beating the PSEi. Remember that this indexes represents the market. Whatever these indexes return is the average. Therefore, to outperform the market, you need to return an higher rate than the return of the index.
📖My Indexing Story
I started investing in late 2017. I did my research and my reason why I started investing was because I wanted to retire early.
I just started working at that year and I am already dreaming about retiring.
I was drawn into the FIRE movement (Financial Independence Retire Early).
This FIRE movement advocated investing in index funds. A mix of stocks & bond index funds.
Also one the first books I read were the books “A Random Walk on Wall street” and "The Little Book on Common Sense Investing. Both these books advocates the passive investing approach.
Over that period from 2017 to 2021, the S&P 500 went from around 2,300 levels to its all time high of 4,700 around November 2021. However I didn’t have access to S&P 500 index funds at that time. If you are living in the Philippines, it is hard to have access to global investments. Especially if you don’t have a lot of money.
I only had investments in PSEi index funds. The PSEi has been flat over the last 5 years. It reaches its all time high around 2018.
PSEI chart from 2015-2023
I’ve managed to accumulate around 200,000 PHP in 3 years on a 25,000.00 PHP monthly salary .
But unfortunately, my investments were flat over that period. I didn’t make any gains. If I had invested in an S&P 500 index funds instead, the story would have been different.
Related Post: Why you should avoid investing in PH stock market
🌕2009 to 2021: To the moon phase
On my example above, I cherry picked the period from 2009 to 2021. I intentionally choose this period because low interest rates and Quantitative Easing started at that year (more on this later).
🐂What fueled the bull market from 2009 onwards (and also the pandemic stock market recovery)
We buy stocks because we buy the companies that are generating profit or cash flows.
Buying a stock is like buying a restaurant in you area. You will buy the restaurant that have a lot of customers because that restaurant makes money.
In theory when buying a stock, that’s all what you should be looking. Whether the business is making money or not. But that’s not the reality today because you have to understand how “Macro things” like interest rates and QE affects stocks.
IMO the stock market did very well since 2009 because of two things:
Low interest rate environment
Quantitative Easing (QE)
Normally we buy stocks because we buy the companies that have bright futures.
A profitable company that will steadily generate profits (value stocks) or companies that has potential to grow and generate a lot of future profit or cash flows (growth stocks).
We buy these companies through shares or stocks. These stocks are price in dollars or any fiat currency. In a perfectly normal world, that’s how it’s supposed to be.
But the low interest rates policy and Quantitative Easing (QE) has helped the stock market to go higher since 2009. I am not saying that these 2 things were the only things that were responsible why the stock market went up.
I summarize below how low interest rates and QE help the stock market to go higher.
How Low interest rates affects stocks
Technically this is know as the Federal Funds Rate. This is the interest rate at which banks and other depository institutions lend money to each other, usually on an overnight basis.
The Central bank lowers the interest rate to stimulate growth in the economy.
Just like what happened during the Global Financial Crisis(GFC) where they lowered the interest rate to fight the GFC.
The Central Bank lowered interest rate again to fight the COVID crisis recession.
The stock market did something interesting during the COVID lockdown. It crashes during the pandemic lockdown then quickly rose to new all-time highs a year later.
How did the stock market reaches all time highs in 2021?If the stock market is the economy, how come the stock market recovered when some parts of the economy is still in lockdown and world hasn’t yet fully reopen??
IMO, Zero interest rates, QE and fiscal stimulus from government are the reasons why stock market reaches all time high in 2021. This was also the peak in cryptocurrency bubble. Remember Axie Infinity, Metaverse and NFTs ?
Lowering interest rates will stimulate the economy through creation of more debt.
Money is created through debt.
When debt is cheap, it encourages risk-taking behavior. It is because you can borrow cheap money and invest it on risky assets that will earn more than your cost of borrowing.
This was the era of easy money. Some economists even say that this era of low interest rate have created a bubble in the S&P 500.
Interest rate is a important macroeconomic topic and explaining it here will make this article very long. But it is important and I plan on making a blog post about the basics of interest rates.
But for now just remember the following effect of interest rates to stocks:
Low interest rate good for stocks
High interest rate bad for stocks
How Quantitative Easing (QE) affects stocks
The short summary of how this QE affected the stock market is that QE injects liquidity or more cash in the system.
More liquidity or more cash in the system reduces the returns of safe investments like Government Bonds, Cash, Term deposits.
Therefore investors will seek more returns on risky assets like stocks.
Low interest rate environment and QE (Quantitative Easing) summary
Low interest rate and QE are important and not so easy topics to discuss. But don’t worry I will make a post in the future explaining this 2 things in a easy to understand post. So stay tuned and subscribe in case you haven’t yet.
In the meantime just remember that Low interest rate and QE are the fuels that ignited the stock market to go higher.
Today those 2 are gone. The question then is how will stock market will go higher if these 2 things are gone?
🚩The challenges of passive-index funds
I’m not buying passive-index fund today because of the following reasons:
Low Interest Rates and QE are gone. The FED is currently hiking interest rates. High interest rates is generally bad for stocks.
S&P 500 is heavily weighted by FAANG stocks. FAANG stands for the 5 of the biggest companies Facebook, Amazon, Apple, Netflix, Google.
S&P is market cap weighted index. Meaning the percentage of companies that has higher market value represent more of the S&P 500. The FAANG stocks more or less represents 20% of the S&P 500 index. It is 500 companies but the bigger company, the more it’s weight in the index. It means that when someone invest in S&P500, 20% of the amount goes to only 5 companies out of the 500. The problem with this is that instead of diversifying, you’re heavily weighted with these mega-cap stocks.
❓Will I buy index funds again?
Yes, but not today because simply the FED is hiking interest rates. Could the S&P 500 make new high again ? Anything is possible.
But today is considered a risk-off environment. I will consider buying index funds again if the FED cut rates.
But what I would buy is an equal weighted index fund. Example of this is Invesco S&P 500® Equal Weight ETF ( Ticker: RSP).
Equal weight simply just means that the fund invest in companies in equally rather than based on market-cap.
This provides more diversification because it reduces heavy exposure to top companies that are in the S&P 500.
Investing in equal weighted index funds has its pros and cons. I recommend reading this article from Lyn Alden for more on equal weighted index funds:
Equal Weighted Index Funds: The Pros and Cons and Which to Pick
That’s all for this post! Stay tuned for more posts that will help you in the future.
https://www.investopedia.com
In the Philippines, the common investment vehicle where to invest in index funds are mutual funds and UITF (Unit Investment Trust Fund). There is also an ETF (exchange traded fund) listed on the PH stock exchange from what I know. The difference is that ETFs are listed and therefore can be trade on an exchange while Mutual funds and UITFs are not traded and listed.
Use Grammarly next time. Difficult read.