Average Returns are Anything but Average
Today, we will deconstruct a common myth about market returns. Before I get started, I recently addressed some common investor mistakes and how to avoid them. If you missed them or would like to reread them, you can do that by simply clicking here, here, and here.
Do you know what the average price return of the S&P 500 index is since 1950? If your guess was between 5% and 10% you are close; since 1950, the average price return for the S&P 500 index is 7.72%. If I asked a sample of individuals, I would assume most would have an answer that is close to the average. Even with that knowledge, many individuals have a preconceived notion and assume their own portfolio returns should be able to earn that average return each calendar year which is the furthest thing from the truth.
Myth: A 7% annual return in the market is normal.
Obviously, the market fluctuates from year to year. The misconception I hear from many individuals is that they expect the return on their portfolio to magically get a 7% return each year. That is a false belief. If you expand that average return into a range between 5% and 10%, how often or what percentage of the time since 1950 did the annual return fall between that range? 20 times? 30 times? 40 times? Here are the actual results.
In just six instances or 8% of the time since 1950 did the return of the S&P 500 fall between 5 and 10%. If you expect to achieve that “average” return every year, you will be sadly disappointed.
You should expect positive returns in the market over the long run with the assumption of earning that average return. What you should not expect is that your portfolio in any given calendar year to return even close to that 7% average. Additionally, you should be happy to see that the results above are skewed to the upside with annual returns greater than 10% in any calendar year to be the most common and happen quite frequently (52% of the time). Lastly, assuming the last 73 years are like the previous 73 years, your expectation for poor returns (<5% return) in any given year is also quite likely (40% of the time).
In the end, average returns are anything but average.
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