Don’t Bank On Average Returns In Stocks This Year

Don’t Bank On Average Returns In Stocks This Year
Stéphane Renevier, CFA

about 1 year ago2 mins

Mentioned in story

The S&P 500 has risen by an average of 7.6% per year (orange line) over the past 95 years (excluding dividends). And that’s roughly what most analysts are forecasting for this year. This makes sense: it’s statistically the most likely outcome, after all.

But sometimes averages are misleading. If you roll a six-sided dice, for example, your “expected” (i.e. average) value is 3.5. But if there’s one thing you should definitely not expect, it’s to roll a 3.5 (assuming you’re sober, of course). It’s admittedly different with investing, but the conclusion remains: don’t count too much on achieving that 7.6% average return this year.

The chart tells you everything you need to know: the S&P 500’s price returns have tended to vary widely around that average. In fact, you’d have seen a yearly return between 5% and 9% on only four occasions since 1927. You’d have suffered a loss larger than 20% on six occasions, and netted a gain larger than 30% on nine. Put more simply, you’re pretty likely to experience anything but average.

This brings us to the matter of time horizon. Stocks tend to generate positive returns over the long term precisely because they’re so volatile over the short term. To compensate for that uncertainty – and the real possibility of enduring big losses along the way – investors require a little extra return. That “risk premium” explains why stocks tend to beat safer assets like bonds over the long term, and why they tend to deliver high single-digit returns. But to realize those average returns, you need a really long horizon. Over one year, anything can happen – good or bad. So make sure this doesn’t come as a surprise, get your horizon right, and don’t pay too much attention to those average Wall Street forecasts.

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