There is No Such Thing as Average

Monday, June 10th, 2019

By: By: Kevin Shuller, CFA®

What type of returns do you expect from stocks in 2019? Most investors will say something between 5-10%. The most bullish will say 15%. Why shouldn’t they? S&P 500 returns about 9% a year. If we give ourselves 50% wiggle room, that gets us to 5-15%. Why not play it safe and expect the average?

Average rarely happens.

It’s not just in investing. In life, the average rarely happens. Coin tosses don’t land on their edge. You will never roll a 3.5 on a standard die. Families don’t have exactly 2.3 children.

Averages are nice, but they don’t tell you much about what will happen in one instance when the range of outcomes is wide.

Equity markets’ return distribution is far more dispersed than most people expect. My extremely unscientific poll of people working in financial services showed that pros expected 5-15% returns from the S&P 500 over half the time. It happens 23% of the time. They overestimated its occurrence by 2x and they do this for a living!

In the last 90 years, the S&P 500 has been down 1/3 of the time, gained 17+% a third of the time, and between 0 – 17% the other third of the time. The average year that we mentally apply to our investments every January rarely comes to pass.

Average happens over longer periods of time. Over 5-year time frames, the S&P 500 returns between 5-15% over half the time vs ¼ of the time in one year.

Projecting stock returns is like rolling a die. If you roll a 1 or 2, subtract 5% from your investments. A 5 or 6? It’s a banner year – add 20%. If you roll a 3 or 4, you get the average. Add 8% to your stocks. You might be hesitant to play that game once. If you can play it year after year, you’d be silly not to. That’s what you get to do when you are a long-term investor.

Annual stock returns have a wider dispersion than most investors – professional and amateur – are prepared for. It is important to set your expectations properly so as not to become disappointed and discouraged. You only lose if you stop playing the game.

 

 

Figure 1: https://twitter.com/NDR_Research/status/1115629392187752450