The Central Theme
The video challenges the common investor belief in the reliability of long-term historical stock market charts. It argues that these charts, often presented as factual evidence of guaranteed future growth, are built on a shaky foundation of back-tested, hypothetical, and biased data, making them a poor guarantee even of the past, let alone the future.
Key Points and Arguments
- Historical Data is Often Hypothetical: Many widely-used historical stock market charts plot performance from periods long before the products they track (like the S&P 500 index fund) even existed. Index providers like MSCI openly state in their methodology that historical data is often “back-tested,” meaning modern rules were applied retroactively, which is not the same as actual, real-world performance.
- Survivorship Bias Inflates Returns: A significant flaw in historical data is survivorship bias. Early records often only account for successful, surviving companies, ignoring those that went bankrupt or vanished. This is like studying cats that fell from buildings by only looking at the ones brought to the vet—the dead ones are missing from the data, skewing the results to seem less dangerous. This bias makes past returns appear higher than they actually were.
- Data is Prone to Error and Misinterpretation: Early market data was recorded manually (chalkboards, telegraphs) and was susceptible to loss and inaccuracy. Furthermore, academic research often builds on previous work, creating a “Chinese whispers” effect where initial errors are carried forward and amplified. For example, foundational research on 19th-century returns was later found to contain errors that overstated performance.
- The “Rules of the Game” Have Changed: Comparing today’s market to the market of the 19th century is like comparing a jet engine to a horse. The composition, rules, and global nature of the market have changed dramatically. Sector definitions (like ‘tech’), index calculation methods, and the scope of the “global market” are all relatively recent inventions.
Conclusions and Takeaways
- Be Realistic, Not Fearful: The goal isn’t to stop investing. The data, even with its flaws, still shows that markets have produced positive returns over the long term. The key is to be more realistic and less certain about historical averages.
- Question US Outperformance: Assuming the US market will continue its historical outperformance is a form of survivorship bias—you’re betting on the winner after the race has been run. A globally diversified approach remains a prudent strategy to avoid catastrophic loss if the winning market changes.
- Stress-Test Your Financial Plan: When planning for retirement or other goals, don’t rely on a single historical average return. Use a range of potential outcomes to stress-test your plan and ensure it’s robust enough to handle future uncertainty. The further back the data goes, the less it resembles science and the more it becomes an artful reconstruction.
Mentoring Question
Given the inherent uncertainty in historical data, how have you stress-tested your own investment plan? Are you relying on a single, optimistic average return from the past, or have you considered how your financial goals would hold up under a wider range of possible future outcomes?
Source: https://youtube.com/watch?v=YilG6KzdlgQ&si=jLqBBJ0aK3EqWMPQ