Reflections

Average Returns Aren’t Normal, Normal Returns are Extreme

You have many ways to achieve your financial goals: your choices, spending habits, how much you save, how much you earn, and of course, your investment returns. If your ability to save and invest is the gasoline that powers you along your financial roadmap, your portfolio returns are the engine that get you there. With smart choices and hard work, you’ll be coasting into retirement and once you’re there, you’ll be feeling good about your patient and disciplined investment program. The issue? Investment returns are impossible to guarantee, and in the short-term, just as difficult to predict.

Most investors are familiar with the idea of planning around a long-term average return. We might typically estimate an average stock return of 8-10% per year (in fact, the S&P 500 Index has returned an annual average of 10.1% since 1926).* But will you actually earn 10% in a single year? Almost never. Instead, actual returns fluctuate significantly above and below the long term average. This roller coaster of highs and lows is what investors really feel, perhaps yourself included, as you reviewed your year-end statements.

The table below shows how the S&P 500 Index returns have been distributed since 1926. Over the 90 years provided, there have been only two years when the annual return was within even 1% of the long-term average! This means that if you expect your portfolio to return 8, or 10, or 12% per year, more times than not, you will be far off in your estimate.

The average return is in fact exceedingly rare. Planning with a long-term average in mind works because if you set your time horizon and stay committed to the long-term, the averages can be achieved. But no portfolio grows steadily each and every year at a target percentage because the markets are far more volatile than simple averages suggest.

Some other interesting historical points that can be read from the table:

  • Markets are good much more often than bad. Stocks were positive 73% of the time, in 66 out of 90 years.
  • Big years are frequent. Stocks are up significantly (>20%) in 33 of 90 years, or 37% of the time.
  • Painful years bring strong recoveries. The four most recent years when the market was down 20% were each followed by a year up 20% or more (1937/38, 1974/75, 2002/03, 2008/09).
  • Positive years often beget more good news. In 15 years when the market was up 20% or more, the following year was up another 10 or 20% or more.

The benefits of long term investing are clear: good returns outweigh bad, strong years are frequent, and with the right commitment and planning, your target return averages can be achieved. But you’ll need to set your expectations for a market roller coaster that moves much more than the average might suggest in a given year. Do that and your portfolio engine will stay well-tuned for success.

 

Windgate does not provide tax advice. Consult your professional tax advisor for questions concerning your personal tax or financial situation.

Data here is obtained from what are considered reliable sources; however, its accuracy, completeness, or reliability cannot be guaranteed.

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