This is a question I get from almost every new client I interact with…and almost everyone has a different opinion. Lots of the time it has to do with either the recent past experience or something they read a long time ago. Should we use long-term average returns? Should we use the returns over the last five years and extrapolate those?
The past 118 years include several golden ages, as well as many bear markets; periods of great prosperity as well as recessions, financial crises, and the Great Depression; periods of peace, and episodes of war. In order to obtain a realistic understanding of what long-run returns can tell us about the future, it is important to have a large data set.
According to the Credit Suisse Global Investment Yearbook, stock markets in the developed world delivered an annualized 9.6% return over the 118 years leading up to 2018.
In the book Debunkery, Ken Fisher found that from 1926-2009 the annualized return was 9.7% and the simple average was 11.7%. However, actual 12 month periods rarely looked like that. Returns were between 10-12% only 5 times in 84 years!
66% of calendar years produced returns either north of 20% or worse than -10%!
Normal returns are hardly normal. Maybe that is why so many investors struggle with the markets. Maybe the investment community is getting its messaging all wrong. I started my career on Wall Street. I learned a tremendous amount from my time there. One of the key lessons I learned is that Wall Street is a marketing machine. Do investors really understand that 2/3 of the time their hard-earned savings invested in the stock market would earn more than 20% or lose more than 10%? That is a lot of volatility for the average investor to handle. Maybe that is why emotions sometimes get the best of us.
If you are waiting on stocks to earn you their normal 9.6% or 9.7% return you may be waiting awhile. Sharp declines followed by soaring recoveries are the norm…both for individual stocks, industries, and markets.
If those single-digit returns are so hard to achieve in a calendar year, why do so many Wall Street “strategists” year after year prognosticate that stocks will earn somewhere between 6% and 11%?
The daily noise, the talking heads on television and the Wall Street strategists are consistently telling the public to expect something that happens less than 1/3 of the time. Why do they constantly prognosticate something that statistically is unlikely to occur? I have my opinions, but I will keep them to myself.