Average Returns Aren’t Normal

When Fisher Investments UK looks back through history, we note many Ponzi schemes and investing scams have this in common:  They promise steady, positive returns that are close to the 10% historic average annual return of equities—as measured by the S&P 500 Index.[i] The siren song of smooth, positive returns with limited volatility can be hard to resist. Wouldn’t it be great to grow your assets predictably, with no unforeseen or uncomfortable dips in value? The only problem is that this is too good to be true. “Average” market returns simply aren’t that normal.

Before providing more evidence about the rarity of “average” returns—a brief warning. You may recall Bernie Madoff lured investors with the promise of steady, positive returns. The accounts he managed were allegedly up even in years when most of the market was down. But it’s also important to remember Madoff’s promised returns were substantially less than market returns in the many years when the market was up big. This suggests that many of Madoff’s investors were motivated less by greed (the desire to make as much money as possible) than by fear (the desire to minimise their losses). Some of Madoff’s victims reported that they were being conservative because they weren’t looking for outsized returns. Rather, they were looking to avoid volatility, a desire which can be partly explained by a key insight of behavioural economics: Investors typically find losses more painful than they find similar sized gains pleasurable—a phenomenon known as myopic loss aversion.

Whilst the average return of the US S&P 500 equity index is around 10% per year, if we look at the distribution of market returns of the S&P 500 since 1926 (Figure 1), Fisher Investments UK’s research found something that may be quite surprising: lots of variation! Notice that market returns do not fall into a normal distribution—also known as a bell curve. Nor are they randomly distributed. Historically, the most common results have been up or up big. Markets have been up more than 20% in over 36% of years. Markets have been up from 0% to 20% over 36% of the time.  We have seen negative returns only 27% of the time.

Figure 1: S&P 500 Annual Returns, 1926–2018

Source: Global Financial Data, as of 17/10/2019; S&P 500 Total Return Index from 31/12/1925 – 31/12/2018. Presented in US dollars. Currency fluctuations between the US dollar and pound may result in higher or lower investment returns.

Fisher Investments UK believes the most important takeaway from this is that in any given year normal returns—the 10% long term return of equity markets as represented by the S&P 500—are quite uncommon. In fact, far from being normal, normal returns are quite unusual. Markets have been far more often than not, but market returns have varied greatly. Annual returns of around 10 percent to are quite rare. Since 1926 the S&P 500 has returned between 10 percent and 12 percent in a year only five times (1926, 1959, 1968, 1993 and 2004). Other countries’ equity markets have seen similar historical results. If a potential investment promises regular returns in this range, as Madoff did, it may be a red flag. It’s a potential warning sign because average equity returns are really quite rare and it’s very unlikely for any investment strategy to achieve average equity returns year over year.

Achieving Average Returns Over the Long Term

If you’re an equity investor, your annual returns are going to be highly variable. As we’ve seen, on the way to 10% average historic returns, in any given year, markets may be up or down a lot, up or down a bit, or largely unchanged. Fisher Investments UK advises long-term equity investors with high growth goals to be prepared for highly uneven annual returns. This can require patience.

You’ll also need to stomach the volatility that is part and parcel of equity markets. If you try to sidestep ordinary market volatility, perhaps by pulling out of the market during a correction, you’re likely to make mistakes that will eat into your long-term returns. For example, you might end up selling after equities have already fallen and buying back in after they have partially recovered. Volatility is your friend, if you let it be. But if you try to minimise volatility by moving in and out of equity markets you will also likely fall short of equities’ historical returns.

Being an average investor—in the sense of realising average equity market returns is pretty great. Ten percent annual returns over the long term is nothing to sneeze at. But you won’t achieve this if you’re not able to tolerate the volatility of equity markets. Remembering that annual returns vary widely and that average returns of around 10% are rare can hopefully help you stay the course and become a successful “average” investor. In many endeavours being average is likely not what you’re aiming for. But, when it comes to investing, realising average returns is tremendous. Many “average” investors, however, underperform the market, in large part because they are unable to tolerate market volatility. Fisher Investments UK believes understanding that average returns are not typical can help you become a more successful investor and realise average returns over the long term.

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Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: 2nd Floor, 6-10 Whitfield Street, London, W1T 2RE, United Kingdom.

Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.

[i] Global Financial Data, as of 17/1/2018; S&P 500 Total Return Index from 31/12/1925 – 31/12/2017. Historic returns of other broad equity indexes have been quite similar.