Jul 18, 2022 FAS Market Update July 2022
Posted By FAS Team
Averages are a crucial component of the investment framework. Advisors couch many discussions with clients around long-term averages. It is an efficient method of determining probabilities of outcomes to help investors’ reach their goals. A downfall to this approach is the assumption these averages are steady or linear from year to year. When in fact it is quite the opposite. To increase the odds of success and avoid poor investment decisions, it is important investors keep in mind how jagged short-term results are to achieve long term averages.
Dating back to 1926, the chart below provides an “average calendar-year return” (black dot) for each investment allocation spectrum ranging from all bonds to all stocks. As one would expect, allocating more towards 100% stocks provides the greatest average calendar rate of return at 10.5%. What is also to be expected is the range of outcomes or risk is greater as stock allocations are increased. For example, for a 100% stock portfolio, the “greatest calendar-year gain” (green bar) was 54.2%. Conversely, the “greatest calendar-year loss” (orange bar) was (-43.1%).
Many investors understand the concept of wider short-term variability of returns and increased risk. What can be lost is how frequently the variability lands outside of historical long-term averages. Analyzing the last 96 years of S&P 500 Index calendar returns, the bar chart below clumps ranges of returns together. Again, the average annual return was 10.5%. The following points are a few key observations.
- The first being the S&P 500 has provided positive returns 74% of the time since 1926. Historically investors’ have been rewarded by allocating to stocks. This skewness of positive results may be part of the reason why calendar years of poor returns are so painful. Negative results haven’t occurred as frequently.
- The second observation is how infrequently the calendar returns have been close to the long-term average. Viewing the 8-12% range, there have only been 6 of the 96 years where returns fell in this range. This reinforces how jagged short-term returns have been to produce the long-term averages.
- The last observation is for calendar year returns in the far-left corner of less than (-20%) or more (except for the Great Depression era of 1930 and 1931) the next year’s returns were in the far-right column of more than 20%. Some of the best calendar year returns followed the worst returns.
We understand the gyrating historical path markets have taken to produce long term results. Which is one reason why our advisors focus intently on the financial planning process. It allows us to match short term needs and long-term goals with the appropriate asset allocation. Additionally, we stress test portfolios to account for the variable natures of returns through sophisticated portfolio simulations. This method supplements long term averages to identify probabilities of financial success through many market environments accounting for the unpredictable paths of short term results.