So what are these charts? It’s a pretty good bet that they’re investment related, or I probably wouldn’t be sharing them with you. Given that, do you like one of the charts better than the other? Does one of them make you feel better, or is one more or less scary, than the other? Which one would you rather invest in? Why?
Alright, let’s get to it. Some of you may have recognized Chart #1; it’s the price of the S&P 500 since 1928 to now. 2 points if you got that one without me telling you.
So what, pray tell, is Chart #2? It covers the same time frame, clearly. Could it be increased trading volume or increased volatility? Could it be the consumption of consumer goods? The growth of Disney from Steamboat Willie to the introduction of Disney+? I can’t wait to tell you! It’s also the price of the S&P 500 since 1928. 10 points for the win if you got that one right!
How can these rather dissimilar charts both show the price of the S&P 500 since 1928? It’s because they use different scales. Perhaps the easiest way to describe it is that in Chart #1, $10 in 1928 is the same size as $10 in 2020. In Chart #2, 10% in 1928 is the same size as 10% in 2020.
(Chart #1 uses a linear scale and Chart #2 uses a logarithmic scale. You can toggle between these charts or show different time frames at: https://www.macrotrends.net/2324/sp-500-historical-chart-data.)
These different manners of presentation have a profound effect on what we perceive these charts to be telling us. If you lived through the Great Depression, Chart #1 is practically an insult; it’s like the depression didn’t even happen! The decline in 2008 dwarfs the practically invisible 1929 blip. In contrast, Chart #2 shows the roughly 86% loss during the Great Depression for what it was, but 2008 looks like we all bought a couple lottery tickets that didn’t pan out.
Unless you’re extraordinarily interested in financial markets, it’s likely you’ve only ever seen some version of Chart #1. Yet that’s the one that just might make us feel like fools for investing in stocks. I mean, look at it! It just feels intuitive that growth like that can’t continue forever! On the other hand, Chart #2 makes it seem like investing in stocks has been a pretty smooth ride.
So which is true? Well, both charts are accurate and neither provides truth, only information delivered through a certain frame of reference. As ever, truth – if it can be found at all - probably lies somewhere in the middle.
The point in asking you earlier if you preferred one or the other of the charts wasn’t to trick you – and since the charts present identical information, there was no right or wrong answer – but rather to point out how susceptible we can be to how information is presented to us. It would be a shame if someone decided not to invest in stocks based on the seemingly unsustainable growth of Chart #1. And it would be disingenuous to allow anyone to believe that being a stock investor is all sunshine and roses based on Chart #2.
For the past 80 years, stock prices have rarely strayed long from an upward trend line, with excesses reigned in and undervaluations corrected. But, yes, absolutely, it was a bumpy ride. That’s why investing based on time horizon is so important. Money you need next week or even next year shouldn’t be exposed to the unknowable vagaries of the stock market. Yet, stocks have proven over time to be better than cash, bonds, or commodities like gold at keeping up with and beating inflation. When time is on our side, stocks have proven to be the way to go.
Dickens wrote, in the novel whose title I purloined for this piece, “It was the best of times, it was the worst of times…” Investing in stocks when appropriate based on time horizon allows to get the best of time, without the worst of timings.
Kyle Swan, CFP®