Index Investing: SP500 and SPY

SPY: Investing in the whole market.

Perhaps you have heard of the idea that you should just buy the whole (U.S.) Market and stop trying to pick winners and losers.  That's what Buffett (former CEO of Berkshire Hathaway), Blankfein (former CEO of Goldman) and JL Collins (author of The Simple Path to Wealth) among many many others suggest.  If you had invested in SPY in 1993, you would today have 28X as many dollars as you had invested.  Of course inflation has taken quite a toll during that time, but even after inflation, you would have 12X as much buying power with your SPY shares today as you needed to invest in them in 1993.  

The figure above gives quite a lot of information about the performance of the US stock market as a whole over the last 33 years.  To get this information we are looking at an ETF called SPY.  SPY is a "company" whose assets consist nearly entirely of shares of stock in S&P 500 companies.  In fact, SPY currently owns 1.2% of all the shares of each of the 500 stocks in the S&P 500.  1.2% of Google.  1.2% of Apple.  1.2% of Tesla.  1.2% of ... 497 other companies that are in the index.  As constituted, SPY is a great proxy for its stockholders to own a stock that behaves nearly like the entire US economy.

Cumulative Annual Growth Rate (CAGR) over last 20+ years

The top line is the adjusted price of one share of SPY.  Two adjustments are made to the price.

1)    Many of the S&P 500 stocks pay dividends which means SPY is constantly receiving cash dividends from the stock that it owns.  Normally SPY passes this cash out by paying a dividend on the SPY shares.  The first adjustment made is to find the price the stock would have if it reinvested all dividends as they are paid out.  This gives an adjusted share price that accounts for all the earnings on all the shares owned, both the earnings that were retained by the companies and reinvested, and the earnings that were sent to shareholders as dividends.
2)    The US Dollar goes down in value a little bit every month.  This is why a shirt that might have cost you $23 in 1993 will now cost you about 57$.  So to adjust for inflation we re-state all prices in "May 2026" dollars.  So a SPY share that might have cost you $23 "January 1993" dollars in January of 1993 will be shown on our chart above as costing $57 "May 2026" dollars.  In this way, we are able to compare "apples to apples" or "prices to prices" across many decades.  

So with those adjustments in mind we see that the (adjusted) price of a share of  SPY has risen a factor of 12X from 1993 until 2025.  Whatever you could have bought instead of a share of SPY back in 1993, you can buy 12 of them, today if you cash out of your SPY position.  And that's what makes SPY attractive for retirement savings.  Stock is like a bank account that can grow your money by large multiples over the decades.  

The general trend of SPY shares being worth more and more over time can be quantified by fitting an exponential curve to the SPY adjusted share prices and noticing that on this plot it slopes steadily upwards at a rate of 6.2% Compound Annual Growth Rate or CAGR.  So, on average, every year you hold your SPY shares, they increase in actual purchasing power by 6.2%.  

However, while the "trend" is up 6.2% each and every year, the actual stock price varies much more than that and so in real life, we see the stock going up by more than that for a few years at a time, and going down in value for a year at a time, sometimes more.  

Earnings per share (EPS)

The second line down from the top shows the annual earnings in May 2026 dollars per share of SPY.  From 1993 until the end of 2025, the earnings per share have grown 4X, from about $6 per share up to about $24 per share.  That amounts to a CAGR of 3.2% per year.  

The third line down from the top presents the "Earnings Yield".  At any given time, the yield is the annual earnings per share divided by the current price of a share, expressed as a percent.  The y-scale for the "Earnings Yield" curve is on the right hand side of the plot.  From 1993 until the end of 2025, earnings yield falls from 10.4% down to 3.8%.  The yield falls at a CAGR of -2.3% per year, on average.  

If we are buying earnings, the price is going up

A rational investor is willing to pay for a share of stock now because she expects to receive in the future cash that is worth more than the share was purchased for.  The reported EPS is an accounting estimate of how much cash value has been added to the value of each share of the business each year.  Then in 1993 with a yield of 10.4%, it cost us nearly $10 to buy an earnings cash flow of $1/year.  As opposed to at the end of 2025, with a yield of 3.8%, the price of a $1/year earnings had risen to more than $25!  The rise in the cost of earnings cash flow is also seen in the 30+ year period that share prices had increased by 12X, the amount of earnings cash flow per share had only increased by 4X.  If earnings is what we are buying as investors in SPY shares, the price of earnings has tripled!

What happens next?

There are only two notable times that the yields on the SPY shares have fallen as low as they are now.  Those two times are 1) Just before the Crash of 1929 and 2) Just before the Internet Bubble burst in 2000.   Does that mean we are going to get another crash?  Well that is the billion dollar question.  Some say yes because, well, that's what happened before.  Some say no because, well, this time it is different.