The One Ultimate Back Test

Further to yesterday's post, I've kept the Excel spreadsheet where I computed the 10Y returns of the S&P500 for the discussion and it reminded me the precise reason why I started a few years ago to consider to "pound-cost-average" for my long term investments in stocks. This was to me the ONE ultimate back test : the Great Depression decade. If you invested in January 1929 and put all your money on the S&P500, 10 years later you would have suffered a loss of more than 45% of your equity... , but if from January 1929 onwards you invested every year 10% of your fortune, you would have ended up with a +12% return. That's a lousy 1% per annum but still better that a loss of almost half of your capital and of course one have to consider what happened during that decade... If a pound-cost-average strategy would have survived THAT, it should be totally bullet proof, right ? Well, my computations yesterday that showed that from 2000 to 2010 such a strategy would have led to a 5% loss mitigates a bit that point : the time and concentration of the crash years is as well important : in the past decade, the crash came in 2008 at the end of the decade, wiping out years of compounded profit while the Great Depression was a succession of crashes (including German recession in 28, the 1929 crash, bank runs and bank bankruptcies) that were concentrated in the first years of the decade 1929-33.

As Liaquat Ahamed wrote in the epilogue of his excellent book The Lords of Finance  (The Lord of Trading highly recommends the Lords of Finance, seriously it's one of the best book I've read for a while), what happened during the Great Depression would be equivalent to see the mexican peso crisis in 1994, Argentina and Asian crises in 1997, the dot-com stock crash in 2000 and the 2007 subprime crisis (I'm not sure if when the book was published, Lehman had bankrupted yet...) happen during a 2-year period... That is pretty concentrated...

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