Investors often get caught up in the idea of "average returns." Today, Alex Cabot and Ed Lambert of Birch Run Financial explain why that mindset can be dangerous. Average returns can be looked at over a longer period of time, but very few years are even close to "average."
First, Ed explains the concept of standard deviation - and the expectation that 66% of years can be expected to be within one standard deviation. Here's an example:
A portfolio's average annual rate of return is 6%, with a standard deviation of 10% in either direction.
That means, in a 30 year period, the return will be between -4% and +16% in 20 of those years.
However, that means in the remaining 10 years, you'll see returns less than -4% or more than +16%. Understanding the math and knowing that these wild swings can happen in individual years can prevent making rash buying or selling decisions based on market conditions. This is explained in Alex an Ed's book, Mastering the Money Mind (link here.)
In the second part of our episode, Alex breaks down the historical numbers that reflect this idea. Since 1980, the S&P 500 has achieved an annualized price return (not including dividends) of 9.4% per year.
How many times since 1980 has been within even one percent of that average (8.4%-10.4%)? Just twice.
What about within two percent? Just three times.
Ten percent? The S&P was within 10% of it's average only 18 times since 1980. That means it returned less than -0.6% or more than +20.4% over twenty times in the last 4 decades! So while an average is helpful to look at in the long term, we simply can't chase it on a year to year basis.
Investors often get hung up in what they are invested in, as opposed to why they are investing - which is to grow their money over a long time period. Alex, Ed, and Jag conclude by talking about "zooming out" on the graph to see long term trends. And Alex explains how to do this to get an accurate representation of historical data.
Finally, Alex and Jag mention their Moms - and how supportive they've been. You'll hear how that ties in to our conversation.
Have questions about your financial future? Alex and Ed are always happy to have a conversation, whether you're a client or not.
You can always email them at info@birchrunfinancial.com or give them a call at 484-395-2190.
Or visit them on the web at https://birchrunfinancial.com/
Alex and Ed's Book: Mastering The Money Mind: https://www.amazon.com/Mastering-Money-Mind-Thinking-Personal/dp/1544530536