There are several common myths about stock market returns.
Some believe an investor can expect an annual rate of return of 10%. Some say it is 12% and others are as high as 15%.
Unfortunately for many investors, they have banked on these myths, investing for their retirements based on getting returns of 10% to 15% annually.
If an advisor were to tell an investor that those expectations might be unrealistic, the investor would go to a different advisor that will tell him what he wants to hear.
At Cornerstone we do not shy away from reality.
The facts are that the average annual rate of return for the S&P 500 since 1871 has been about 5.63% to 5.85% annually.
This is a far cry from the 10% to 15% many investors are expecting.
The table below shows the annualized return numbers from a 1 year, 10 year and 20 year perspective.
It also shows the Median Annual return, which for the 10 and 20 year time frames is significantly lower than the average annual rate of return.
The problem with these types of numbers is that they don’t tell the whole story. Averages don’t tell you what the range of returns and frequency of those return have been. So we did that analysis as well.
We asked, “how often did a certain rate of return occur?” The answers are in the charts on the next page. You will see that the odds of hitting a rate of return like 15% or even 10% per year is much harder than you think.
What is more interesting is that while the market has had rates of return of 15% or more, over 30% of the time on an annual 1 year basis, it hasn’t been able to string them together.
When looking at the 10 year chart, you will see that the market achieved an annual return of over 14% only about 3% of the time.
This is well below 30% of the time the market returned over 15% on an annual basis when measuring 1 year at a time.
Over 10 years, the market achieved a return of 10% or better return 20% of the time. Investors that were hoping for returns of 15% or more over the long run may be sorely disappointed.
Since most investors identify themselves as long term investors, they should pay more attention to the long term charts and not the 1 year charts. And the 20 year chart is even more revealing.
What the 10 year and 20 year frequency charts show is that while certain rates of return can happen in any given year, the market has not been able to string those winning years together over the long run.
But this research still lacks something. What is missing is putting these rates of return into further context.
We plotted the returns out as they happened and the chart reveals a clear cyclical pattern. The chart below shows the pattern of annual 1 year returns and the average annual returns of 10 year periods.
While the 1 year annual return line (blue line) is very random, the 10 year average annual return shows a distinct cycle.
It was clear that the market was peaking in 2000. What is also clear is that the average annual returns of a rolling 10 year period has hit what appears to be a bottom.
But, the normal duration of the cycle’s bottoming action is 10 to 20 years. So far, the market has been forming a bottom for only about 4 years. It could be 6 to 16 years before the market’s 10 year average annual return starts to head up again.
The smart investor does not ignore the reality of the current markets cycle and blindly chase promises of better returns. Instead, after looking over the hard data, he will lower his expectations to be aligned with what he knows the current environment can deliver.
He then implements a strategy (or finds an Advisor with a strategy), based in reality, that will get him through the current cycle and prepare him to reach his long term goals.
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