The ultimate passive investment strategy

I recently read a paper from Jeremy Siegel and Jeremy Schwartz titled “The Long-term Returns on the Original S&P 500 Firms”.

In this paper the authors calculate the total returns of a buy and hold of the original 500 companies in 1957. They found that on average 20 stocks annually have been added and deleted from the index (without considering that a merger of two S&P 500 companies is an addition to the index) since 1957. The authors also used three methods of calculating the returns:

Survivors’ Portfolio (SP). The survivor portfolio consists only of shares of the original S&P 500 firms. Shares of other firms received through mergers are immediately sold and the proceeds invested in the remaining survivor firms in proportion to their market value. For example, when Mobil Oil was merged into Exxon in 1999, shareholders of Mobil are assumed to sell the shares they received from Exxon-Mobil and invest the proceeds in the remaining survivor firms. All spinoffs are immediately sold and the proceeds reinvested in the parent firm. Funds received from privatizations are sold and the proceeds re-invested in the original surviving firms in proportion to their market value.

Direct Descendants’ Portfolio (DDP), which consists of the shares of firms in the survivors’ portfolio plus the shares issued by firms acquiring an original S&P 500 firm. In the case of the Mobil-Exxon merger discussed above, we assume that shareholders of Mobil Oil hold the shares of Exxon that were issued in the merger. If an original firm was taken private, we assume that the cash distributed from the privatization was invested in an indexed portfolio whose returns matched the standard S&P 500 Index.12 If a firm that was taken private is subsequently reissued to the public again, we assume the portfolio repurchases shares in the reissued company with the funds that had been invested in the index at the time the firm went private. As before, spinoffs are immediately sold and the proceeds reinvested in the parent.

Total Descendants’ Portfolio (TDP) and includes all firms in the DDP plus all the spinoffs and other stock distributions issued by the firms in the Direct Descendants’ Portfolio. The only difference between the TDP and the DDP is that the TDP holds all the spinoffs rather than sell them and reinvest in the proceeds in the parent firm. The TDP is identical to the portfolio of a totally passive investor who holds all the spinoffs and shares issued from mergers and never sells any stock.
My favorite portfolio is the Total Descendants portfolio, since it basically represents a very passive investment strategy – buying stock in 500 companies and then forgetting about them for 50 years.

The authors looked into the return of equal weighted and value weighted returns for the three calculation types.

At the end of the paper they determined that by not updating your portfolio of the original 500 companies, with the annual changes in the S&P 500, you’d have outperformed the average pretty handsomely.

My take on this research is that by purchasing the current 500 stocks in the S&P 500, and allocating all stock equally, an investor will be better off in the long run than simply purchasing an ETF. The reason is that ETF’s tend to charge fees of 0.1% annually, which could really add up over time.

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