A FLOWER GARDEN OF MARKET RETURNS
The US stock market has delivered an average annual return of around 10% since 1926. But short-term results may vary, and in any given period stock returns can be positive, negative, or flat. When setting expectations, it’s helpful to see the range of outcomes experienced by investors historically. For example, how often have the stock market’s annual returns actually aligned with its long-term average? It’s kind of like closing your eyes in a flower garden and picking a single stem.
Exhibit 1 shows calendar year returns for the S&P 500 Index since 1926. The shaded band marks the historical average of 10%, plus or minus 2 percentage points. The S&P 500 Index had a return within this range in only six of the past 93 calendar years. In most years, the index’s return was outside of the range—often above or below by a wide margin—with no obvious pattern. For investors, the data highlight the importance of looking beyond average returns and being aware of the range of potential outcomes.
TUNING IN TO DIFFERENT FREQUENCIES
Despite the year-to-year volatility, investors can potentially increase their chances of having a positive outcome by maintaining a long-term focus. Exhibit 2 documents the historical frequency of positive returns over rolling periods of one, five, and 10 years in the US market. The data show that, while positive performance is never assured, investors’ odds improve over longer time horizons.
IMPLICATIONS FOR RETIREES
Retirees or those close at hand, may wonder how looking at the long-term picture continues to apply after the “accumulation years”. The fact is, different withdrawal strategies such as “The 4% Rule” heavily rely on the notion of continued exposure to the market over a longer period of time. This assumption is also in our Withdraw Policy Statement (WPS), which we put together with each of our clients once they’re ready to make regular withdrawals. The WPS has rules and a process that systematically (not emotionally) spells out when to make adjustments to withdrawal amounts. The other area that applies to retirees is maintaining a target asset allocation of global stocks and bonds and again, systematically making adjustments to maintain the desired allocation. The beauty of this strategy is that it automates the process of “selling high” and “buying low” that happens when you maintain your asset allocation.
While some investors might find it easy to stay the course in years with above average returns, periods of disappointing results may test an investor’s faith in equity markets. This can be particularly unsettling for those who have recently transitioned to retirement. Being aware of the range of potential outcomes can help investors remain disciplined, which in the long term can increase the odds of a successful investment experience. What can help investors, and recent retirees endure the ups and downs? While there is no silver bullet, understanding how markets work and trusting market prices are good starting points. An asset allocation that aligns with personal risk tolerances and investment goals is also valuable. By thoughtfully considering these and other issues, investors may be better prepared to stay focused on their long-term goals, and retirees should be able to maintain their income and distributions plans during different market environments.