Hindsight, we’re told, is 20/20. That pithy expression figuratively meaning “All is clear in retrospect” more literally means “When we consider the past, we have a normal human
understanding of it.” Unless we apply extra acuity, we don’t gain more than average insight. Applying a bit of acuity to averages is my goal today.
It turns out we could quibble all day about what “average” means (pun intended), but I’m using the really basic definition: add up a bunch of numbers and divide by how many numbers you added up. (This is known as “arithmetic mean” and works for this discussion.)
If you average nominal annual S&P 500 index returns including dividends from 1926 through 2019, you get about 12%. You might think it follows that many years have actually returned 12% or thereabouts. But that’s not really the case.
A bullseye right on 12% is pretty unlikely, but it’s happened twice during those 94 years. If we expand the range to +/- 2% (i.e. between 10% - 14%), it’s only happened 8 times. Expand out to +/- 5% and the S&P 500 index has only hit that “broad side of a barn” target on 15 occasions.
That’s astounding. It’s saying that despite an average return of 12%, we’ve only experienced an actual annual return in the range of 7% - 17% 15 out of 94 years, or just 16% of the time.
I guess average doesn’t really happen on average. If it did, being a stock investor would be easier – just sit back and wait for your 12%. Instead, we get negative 37% (2008) or positive 31% (2019). And that’s just as measured by successive December 31sts. During 2020 we’ve been down 34% and up over 50%, a 6-month roundtrip that won’t be registered in future annual returns. As I write this, 2020 year-to-date returns would make this crazy year one of the few to actually be pretty close to the long-term average.
So what’s my suggestion? Just sit back and wait for your return. (Did you see that coming?) But you should commit to a long sit. Our average returns are based on almost the same length of time Abraham Lincoln has been sitting on the National Mall. Thankfully, stock investing does not require that you be made of marble, but losing your marbles and abandoning your plan because of a bad month or a bad year is a recipe for disaster.
So how long is long enough? When should you invest in stocks as opposed to typically less volatile assets like cash and bonds? We tend to use a minimum 5-year holding period as our metric indicating stock investments, and we have reasons for it, but, truth be told, arguments can be made for shorter or longer periods. Making a commitment of less than 2 years is speculative, insisting on fourscore and seven years is too long. Figuring out what is right for you is our vocation and our pleasure. Please reach out to firstname.lastname@example.org to schedule a sitting.
Kyle Swan, CFP®