March 12, 2021

Average Isn't Normal

Dennis Fagan
&
Aaron Fagan

Over the past 25-years for the calendar year-ending 2020 the S&P 500, excluding dividends, has returned an average of 7.50% on an annualized basis. Add in a couple percent in dividends and that average moves up to a little over 10 %. However, the lack of statistically normal dispersion around the mean/average is discomforting for many investors during times of market volatility.

Over that same 25-year period, on a calendar year basis, only once did the S&P 500 returned within 25% of either side of 7.50% (between 5.625% and 9.375%). In fact, only twice did it sport returns within 50% of either side of 7.50% (between 3.75% and 11.25%). Those years were 2004 (8.99%) and 2015 (9.54%).

This is precisely why investors tend to panic when stocks decline. If annual returns were more clustered around the average the average would be much more meaningful. Let’s look at an example of driving from NY to Florida. If you were to leave the Capital Region and drive straight through to Daytona it would take approximately 20 hours. Assume that you did this 25 times. How often do you think the trip would take between 15 and 25 hours? How about between 10 and 30 hours? Certainly you’d predict the majority of trips would fall between 15-25 hours and the vast majority (if not 100%) between 10 and 30 hours.

These driving examples used ranges of 25% and 50% percent on either side of the 20 hour average. Compare that to the average return of the stock market over the past 25 years. Again, not once has the return come within a 25% of the average and only twice within 50%.

This does not render the average meaningless for planning purposes. However, it does render it somewhat meaningless when trying to allay client anxieties.

What is an investor to do? First of all, allocate your investable assets in accordance with your objectives with equities comprising the majority of your long-term holdings and bonds and cash for the short-term.

Have faith.

Over the past 90-plus years, equities have had positive returns 74% of the time. That percentage increases to 86%, 94% and 100% over five, ten and twenty year timeframes. Can we be certain that these percentages will hold true in the future? Of course not. However, given the fact that the ten-year U.S. Treasury note currently yields less than 2.70%, the odds are in your favor that equities will outperform other asset classes.

Correlate your investments relatively tightly to the underlying asset class. Make certain you diversify your holdings across four to six different industries. You therefore will be able to weather any unexpected downturn in a particular sector.

Recognize that there will most definitely be periods of volatility. There will be market downturns. You will lose money periodically. It is unavoidable. You will not be right all of the time. However, the important factor is to be right over time. Don’t appraise your portfolio on a daily basis. It becomes not unlike weighing yourself every day. You will never be happy as the market moves higher on a daily basis only 54% of the time.

Eventually, if you monitor your portfolio too closely you will become exasperated and give up. Measure your performance versus appropriate indices over time and recognize that you will make errors.

What matters during periods of consolidation is that you exit with the right portfolio. Simply put, when evaluating your portfolio you must assess the potential of your holdings in addition to the recent results. For example, do you own the companies with earnings growth potential?

Do you own the companies that are increasing their share of the market? Do you own the companies with a proprietary product or service?

Continue to dollar cost average, investing on a systematic basis through your company sponsored pension plan such as 401(k) or 403(b). Assuming that you are allocated appropriately between stocks and bonds to meet your long-term objectives, it is imperative that you do not make major changes to your investment patterns during periods of market downturns.

Finally, upgrade your portfolio to industry leaders. Do not accept the marginal investments you currently own. Trade up.

Please note that all data is for general information purposes only and not meant as specific recommendations. The opinions of the authors are not a recommendation to buy or sell the stock, bond market or any security contained therein. Securities contain risks and fluctuations in principal will occur. Please research any investment thoroughly prior to committing money or consult with your financial advisor. Please note that Fagan Associates, Inc. or related persons buy or sell for itself securities that it also recommends to clients. Consult with your financial advisor prior to making any changes to your portfolio. To contact Fagan Associates, Please call (518) 279-1044.

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