A Fossil By My Driveway
A while back, I was outside taking the trashcan to the curb when something caught my attention out of the corner of my eye, something yellow and shiny in a plastic bag. I went over and picked it up. It was a book, and in it were names and phone numbers. I believe people used to refer to it as a phone book.
I think I would have been less surprised to find the thighbone of a Tyrannosaurus Rex sitting at the end of my driveway. I expected to open it up and find 10% off coupons for the purchase of a typewriter or an 8-track tape player. Was someone playing some kind of practical joke on me?
R.I.P. Paper Phone Book
Although the paper phone book was once a staple of every American home, it has gone the way of the steam engine, typewriter, vinyl record and bound enclyopedia sets. All of these products and technologies were victims of what economists refer to as creative destruction (not sure what it says about me, but I love that term!).
Creative destruction is the process of a new or better product or technology replacing an older product or technology. Said another way, “Out with the old and in with new!” For example, the personal computer replaced the typewriter. The Internet replaced the paper Yellow Pages. Digital cameras replaced film cameras. Wikipedia replaced the paper encyclopedia (Encyclopedia Britannica recently killed its print edition after 244 years!).
Creative destruction can be a scary thing as an investor if you believe that you need to figure out which technologies, companies and industries will be tomorrow’s winners and losers. A quick look at the track record of most active stock pickers will dispel any illusions you might have that you, or anybody else, can consistently do this.
Making Destruction Your Friend
The good news is, buying a market-based portfolio like the S&P 500 allows you to benefit from creative destruction without having to figure out who its next victims will be. The market, over time, will sort out the winners and losers for you. The failing companies will shrink and eventually leave the index and the rising companies will be added to (and become a larger share of) the index over time.
For example, looking back over the last 50 years, around 1,000 companies were added to, and subtracted from, the S&P 500 Index. If you had been invested in the S&P 500 over that time period, those changes would have happened with no investment research required on your part. Creative destruction did the work for you. In spite of all the ups and downs over that time, $100,000 invested in the S&P 500 Index on January 1, 1962, was worth around $9,700,000 on December 31, 2012 (including reinvested dividends).
It makes you wonder why so many people feel the need to try to outsmart or “beat” the market by deciding which companies will be in favor and which will fall out of favor. It seems to me that rather than trying to beat the market, a better goal is to just be the market. Be the market by buying a highly diversified, market-based fund and letting creative destruction do its work.