If stocks are on fire, why bother with more complicated strategies?

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The S&P 500 has been on a tear. Total returns so far this year (as of December 23) are 26 percent. This is in addition to total returns of 26 percent in 2023.

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This is the kind of investment performance that might make some investors wonder whether Warren Buffet was right when he suggested that the best thing most people could do is own the S&P 500.

Whether this is the right investment strategy for the investor is something he has to decide. This is in no way meant to challenge Buffett’s investment perspective. Or, for that matter, suggest an alternative strategy for individual investors.

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But recency bias can be powerful. So, with the S&P 500 rising as much as it has over the past few years, it’s time to remind yourself why a strategy that involves investing solely in this index requires real patience and conviction at times, and why many investors stick with more diversified strategies.

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The S&P 500 has been a great long-term investment: $1,000 invested there 50 years ago is equivalent to roughly $360,000 today. This beats a 60/40 portfolio of S&P 500 and 10-year US Treasury bonds, which would have grown to only about $136,000 over the same period. It beats investing in other developed markets, such as MSCI EAFE (Europe, Australia and Far East), which would have grown to only around $60,000.

However, much can be lost in the long-term performance numbers, specifically the occasional and very large drawdowns that the S&P 500 has seen, and its poor performance compared to more balanced portfolios and other markets over a number of multi-year periods.

For example, investors who invested 100 percent of their portfolios in the S&P 500 in September 2000 would have lost 45 percent over the next two years, about twice as much as an investor in a 60/40 portfolio. After that, it would have taken 100 percent S&P 500 investors more than six years to recover their losses, and nearly 20 years to catch up to the 60/40 equity investor.

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This was not the only period in which the S&P 500 underperformed a 60/40 portfolio: in the late 1970s, the index performed worse in three years; In the early 1980s, the company’s performance was about six years worse; In the late 1980s, it experienced its worst performance for more than seven years.

Today, investing in the market-cap (as opposed to the equal-weighted) version of the S&P 500 involves betting big on the continued strong performance of a small number of companies. The last time the top 10 companies in the S&P 500 represented as large a percentage of the index as they do today (36 percent) was 1964. None of the top 10 companies in 1964 are in the top 10 today. In fact, three of them (General Motors, Sears Holdings, and Eastman Kodak) went bankrupt and two merged into other companies (Gulf Oil Corp. and Texaco).

It is also important to remember that although US public equity markets have been a good investment over the past 50 years, non-US public equity markets have delivered better returns over multiple multi-year periods. For example, between 1985 and 1989, the S&P 500 underperformed the MSCI EAFA (Europe, Australia and Far East) index by 13.82 percent per year on average. Once again, the S&P 500 underperformed this index between 2000 and 2009 by 2.65 percent annually on average.

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For all these reasons, a comprehensive S&P 500 investment strategy requires, at times, real psychological ability on the part of individual investors. For many institutional investors, an entire S&P 500 strategy can lead to drawdowns and periods of poor performance that would be difficult to manage when more balanced and less volatile strategies were possible.

Many institutional investors do not try to achieve the highest possible returns in the short term. They attempt to generate stable, long-term returns to cover a specific liability (such as pension liabilities), while minimizing return volatility. Large fluctuations in returns may be difficult to manage in the near term and require increased contributions. This can lead to generational injustice if shareholders need to pay more than previous generations because the fund was invested in a strategy that was unnecessarily focused and risky.

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For this reason, despite the very strong performance of the S&P 500, many investors still choose more diversified investment strategies, combining non-US assets, as well as government bonds, credit, real estate, infrastructure, and public and private asset classes. In times like these, with the S&P 500 continuing to deliver outstanding returns, it’s good to remember why.

Bert Clark is President and CEO of Investment Management Corporation of Ontario (IMCO), an investment trust that manages $77.4 billion in assets for Ontario’s public funds.

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