Anything But Average
Key Takeaways
While the annual average return of the global market in the past 20 years is +5.69%, the actual annual return ranges from -42.77% all the way to +49.14%.
Market returns fluctuate as investors update their expectations of the returns of the stocks that they hold depending on their reaction to new information each day. This is how price volatility occurs.
By investing in a diversified and systematically indexed manner and holding for long periods, you are able to gain more consistent returns in the long run, which makes planning for the future much more feasible.
Facts are stubborn, but statistics are more pliable
— Mark Twain
We once wrote an article where we highlighted a joke about a statistician. The way that joke goes is there was a statistician who laid down with his head in an oven and his feet in a freezer, happily proclaiming “On average, I feel comfortable.” Well, here’s another; Three statisticians were hunting in the woods. They see a deer and two of them shoot. One missed by a metre to the left. The other missed by a metre to the right, and the other shouted “We got him!!!”
Unfortunately, when it comes to investments, most people think like the statisticians. Ask most people what kind of return they expect from their investments in any given year, and many will respond with a historical average return. In general, global stocks provide an 8% average return and global bonds are around 4% but the annual returns of these two asset classes almost never fall close to the average.
Using the S&P 500, which has a very long history, shows us that what we end up getting from stocks is likely to be far from the average. Since 1926, only 15 out of 98 years had returns within five percentage points of the 12.2% average. In the other 83 years, the average deviation was over 18 percentage points!
More Than A Quarter up, or A Whole Half Down
Global stock markets are no different. Looking at recent history, only 2012 and 2014 come close to the average return. In all other instances, markets can be +25% or even -50% away from the average. So if you think that the returns that you will receive from your investments are always steady, then you are inadvertently thinking like the 3rd statistician.
Actual returns deviate from expected returns because information and circumstances change. If the news is better than expected, markets may go up. Of course, the reverse is true if the news is disappointing. In an interconnected world where news flow is often rapid — the economy, elections, geopolitical conflict, etc. — it shouldn’t be a surprise that we often receive returns either much higher or lower than the long-run average.
Adjust Your Expectations, Everyone Else Does
Why do market returns fluctuate so much then? When investors adjust to new information everyday, they adjust to this information by updating their expectations of the returns of the stocks that they hold. If the new projections are below what they are looking for, they would probably sell. If they like the new information, then they would likely buy. This rapid change in price is what we know as price volatility.
Bear in mind that each investor has their own expectation and timeframe — some buy stocks intending to only hold for 6 months, some look at periods of 20 years and beyond. As such, each individual may react to the same piece of information differently.
However, there is a special method to push your investment returns close to the average.
First, You need to invest in a diversified, systematically indexed manner.
You are unlikely to see the following results if you are investing in a handful of individual stocks.
Next, Hold for a long time.
You will see that the variance in your returns shrinks towards the average.
The diagram below shows this — investing for a 1-year period in a global stock market index will give on average an 8.37% return. However, your actual return can range from -42.77% all the way to +49.14%.
When you start to hold for 15 years or more, your best and worst return variances shrink (+2.46% to +7.38%) and are very much closer to the average of 5.69%.
A lot of our core portfolios are built with this philosophy in mind and this is one of the main reasons why we advocate matching long-term goals to investments when we conduct our planning. Investors with short-term goals will need to adopt a trading mindset and be prepared for a wide range of outcomes. If you are unprepared for this, then investing is perhaps not for you. All of this will be discussed in detail and charted out when you work with us.
