The uncommon average
"I have found that the importance of having an investment philosophy - one that is robust and that you can stick with - cannot be overstated"
David Booth
The world stock market has delivered an average annual return of around 10% since 1988 (1). But short-term results may vary, and in any given period stock returns can be positive, negative, or flat. When setting expectations, it’s helpful to see the range of outcomes experienced by investors historically.
For example, how often have the stock market’s annual returns actually aligned with its long-term average? To answer this question, we have looked at the US stock market which has a much longer track record and has also delivered an average annual return of around 10% since 1926 (2).
Exhibit 1 shows calendar year returns for the S&P 500 Index since 1926. The shaded band marks the historical average of 10%, plus or minus 2 percentage points. The S&P 500 had a return within this range in only six of the past 91 calendar years. In most years the index’s return was outside of the range, often above or below by a wide margin, with no obvious pattern. For investors, this data highlights the importance of looking beyond average returns and being aware of the range of potential outcomes.
Exhibit 1: S&P 500 Index Annual Returns 1926–2016
The S&P data are provided by Standard & Poor's Index Services Group. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.
Tuning In To Different Frequencies
Despite the year-to-year uncertainty, investors can potentially increase their chances of having a positive outcome by maintaining a long-term focus. Exhibit 2 documents the historical frequency of positive returns over rolling periods of one, five, 10, and 15 years in the US market. The data shows that, while positive performance is never assured, investors’ odds improve over longer time horizons.
Exhibit 2: Frequency of Positive Returns in the S&P 500 Index - Overlapping Periods: 1926–2016
From January 1926–December 2016 there are 913 overlapping 15-year periods, 973 overlapping 10-year periods, 1,033 overlapping 5-year periods, and 1,081 overlapping 1-year periods. The first period starts in January 1926, the second period starts in February 1926, the third in March 1926, and so on. The S&P data are provided by Standard & Poor’s Index Services Group. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.
Conclusion
While some investors might find it easy to stay the course in years with above-average returns, periods of disappointing results may test an investor’s faith in equity markets. Being aware of the range of potential outcomes can help investors remain disciplined, which in the long term can increase the odds of a successful investment experience.
What can help investors endure the ups and downs? While there is no silver bullet, having an understanding of how markets work and trusting market prices are good starting points. An asset allocation that aligns with personal risk tolerances and investment goals is also valuable. Financial advisers can play a critical role in helping investors sort through these and other issues as well as keeping them focused on their long‑term goals.
[1]. As measured by the arithmetic average of calendar year returns of the MSCI All Country World Index (gross div.) from 1988 to 2016. MSCI data © MSCI 2017
[2]. As measured by the S&P 500 Index from 1926–2016. S&P data provided by Standard & Poor’s Index Services Group.
Source: Dimensional Fund Advisors.
Risk Warning
This newsletter does not constitute financial advice. Remember that your circumstances could change and you may have to cash in your investment when the value is low. The value of your investment and any income from it can go down as well as up and you may not get back the original amount invested. Past performance is not necessarily a guide to the future. If you are in any doubt you should seek financial advice.
Max Tennant - November 2017
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