Better odds

Over the last 55 years, the S&P 500 has lost 50.1% from 1973 to 1974, and 50.5% from 2000 to 2002. Since inception, the index’s annualized return has been 7.8%. In other words, traditional investors take the risk of losing half of their money within two to three years, to get a chance to double their money every nine to ten years.

If you assume a 2% total expense ratio (roughly the current annualized cost for the average mutual fund), it would take you more than twelve years to double your money on average returns. Does that sound right to you?

Let’s now examine the probabilities for future market returns. For the last eighty years, the normal range for the price to earnings (P/E) ratio of the average company in the S&P 500 index was between ten (undervalued) and 20 (overvalued). Every time the average P/E went above 20, it has come back to less than 10 before going back up.

Corporate earnings growth has hit a peak of 6% recently, at which point it usually starts to slow, and the S&P 500 price/earnings ratio is still above trend as of 2008. If we assume that the market P/E will revert to somewhere between seven and fourteen, the most probable returns for the market for the coming ten years is somewhere between -4% and +5% per year.

That means a worst case scenario loss of 33%, and a best case scenario of a 63% gain until the end of 2017.

With inflation currently at 3% per year, that leaves us, if we’re lucky, with real gains of 2% per year or less than 22% until the end of 2017. If you invest through a fund with the average total expense ratio of 2%, the best case scenario is zero real gains.

When you're running the risk of losing 50% of your money at any time, and your best case scenario is roughly to make zero money, the conclusion is that

INVESTORS ARE CURRENTLY NOT BEING PROPERLY COMPENSATED TO TAKE MARKET (SYSTEMIC) RISK.

The solution? Simply to eliminate most of it.