Uncommonly Average Returns
MONEY TALKS – A general misperception about the financial industry is that a 10% or 12% annual return is common. While this is certainly possible in any given year, statistically it’s very unlikely that an investor will realize these types of returns over any one year period. In Norman Vincent Peale’s book The Power of Positive Thinking he states that “our happiness depends on the habit of mind we cultivate.” This seems to be particularly accurate when it comes to gamblers and your rose-colored investor. Everyone has a friend, relative, or neighbor who “wins” every time they go to Vegas. Likewise, we’ve all encountered the unabashed investor who revels in sharing how well their portfolio performs year-over-year. The fact of the matter is, when you ignore losses and only tally the wins, your scorecard looks pretty darn good.
The good news is, about three quarters of the time the annual return on the U.S. stock market is positive (i). In fact, since 1926 the S&P 500 Index has delivered an average annual return of around 10%. Based on these figures, one could easily conclude that your loud-mouth neighbor might actually know what he is talking about. However, when the stock market’s annual returns are compared to the long-term average, it paints an entirely different picture.
Exhibit 1 (ii) shows calendar year returns for the S&P 500 Index since 1926. The gray shaded band marks the historical average of 10%, plus or minus 2 percentage points. Based on conventional wisdom, one might reasonably conclude that an 8% to 12% return is to be expected. Surprisingly, this could not be further from the truth. Over the past 91 years, the S&P 500 Index has only yielded a return within this range six times. In other words, in 85 of the last 91 years the annual return on the U.S. stock market was either below 8% or above 12%. Even more shocking is the wide margin of the index’s returns and the lack of any measurable pattern.
Despite the year-over-year uncertainty of the market, the long-term investment results tell a different story. From January 1926 through December 2016 there were 973 individual 10 year periods (the first period starting in Jan 1926, second period starting in Feb 1926, third period starting in Mar 1926, and so on). Of those 973 individual periods, 94.6% had positive returns (iii). The longer the period, the higher the probability of success. While nothing is guaranteed in life (except death and taxes), virtually all the 15 year periods since 1926 had positive outcomes. Clearly there is a high correlation between time and the success, or failure, of an investment portfolio.
Aligning expectations with reality and understanding the potential return outcomes is critical for any investor. While enduring the ups and downs of the market is par for the course, it’s how an investor reacts to the swings in the market that will ultimately dictate their odds of success. Staying grounded and remaining disciplined during tumultuous times may prevent erratic behavior that could compromise your investment returns. Understanding that there is no such thing as a common or expected annual return in the stock market may provide comfort and fend off potential disappointment, thereby allowing an investor to focus on the long-term.
i As measured by the S&P 500 Index from 1926 – 2016
ii Exhibit 1 provided by Dimensional Fund Advisors LP
iii S&P data provided by Standard & Poor’s Index Service Group via Dimension Fund Advisors LP