Returns are almost never average
Do me a favor and do not scroll down to the chart below until you read this. Today we will learn something about market history and we might also learn something about the human mind today, especially as it relates to investor psychology. I love educating. I love to be educated. Few things are more healthy for the mind than the introduction of a new idea, a new concept, a new thought presented that makes you say “wow, that’s interesting.” I hope to cause that to happen for you today.
During a presentation I gave this spring to a group of NFL football players, I showed them historical average returns over the past 92 years for "stocks" and "bonds", as generally as we can describe the two asset classes. Here are what 'stocks' and 'bonds' have averaged:
U.S. Stock Market = 10% average nominal return
U.S. Bond Market = 5% average nominal return
These are the facts. Now, the fun part. Given this set of facts, I pose you this question: on any given random year, if we take a sum of money and invest it in that very stock market we are discussing — the one that has averaged 10% per year over the past 92 years — what would you expect the return to be this year? Often people will say, well, hmm... about 10%. If they really think about it for a minute or two they might say, “On a bad year, 2 or 4 or 6% and on a good year 12, 14 even 16%”... somewhere in a little range on either side of 8-10%.
People answer the question this way because that is how we are programmed as humans. Having been told a long-term average, we then take that information and expect that the most likely scenario is that any given year will be “average”, or certainly within a fairly tight range around that average.
Here’s the thought provoking truth — Returns are almost never average. I will say it again for emphasis — Returns are almost never average. I direct your attention to the chart:
This chart shows each calendar year from 1926–2017 (92 points = 92 years), plotted at the intersection of that year’s stock return and that year’s bond return. The vertical shaded area contains all years for which the stock return was between 8% and 12%. The horizontal shaded area contains all years whose bond return was between 3% and 7%.
So, each dot is one year's return, plotted where stocks and bonds intersect. To simplify what we are getting at here, notice this: Stocks had an "average" return (between 8-12%) a grand total of six times in 92 years. Six. Bonds were historically less volatile, yet still had twice as many years outside of their "expected range" than they had inside of it. (62 outside vs. 30 inside). Furthermore, only twice in 92 years would an investor get to the end of the year and say, "stocks and bonds both did what they were 'supposed' to do this year."
This, by the way, is not bad news. But it is news. And we should all consider these facts about the history of market returns and their impact on our approach to investing. I’ll discuss the implications of this news in future posts. For now, it will serve us well to let this marinate — Returns are almost never average.