The most prominent disclaimer in the financial services industry almost certainly is this: “Past performance is no guarantee of future results.” There are good reasons that regulatory agencies like the SEC and FINRA require this disclaimer in all communications that might find their way to consumers. To note just one example: The S&P 500 index, representing the largest U.S. companies by stock value, had the following returns around the turn of the century: +33.10% (1997), +28.34% (1998), +20.89% (1999), -9.03% (2000), -11.85% (2001), -21.97% (2002). For investors trying to decide whether, and when, to invest their hard-earned savings, those are hard numbers to take.
Contrast that with statistics on the long-term performance of stocks. From 1928 through 2016, stocks in the S&P 500 had an annual geometric average return of 11.42%. That’s a number that many investors may be comfortable with. The catch, of course, is that the returns in individual years were much more volatile. The S&P 500 index was down 43.84% in 1931 and 36.55% in 2009; it was up 49.98% in 1933 and 52.56% in 1954.
So, how do we reconcile the fact that stocks have been profitable in the long-term with the bitter reality that they could lose a significant amount of their value in a given year? One answer is to focus on returns over longer periods—five, ten and twenty years. Over an even longer time period—1871 to the present—the S&P 500 stocks have been down over a five-year period just over 10% of the time. Put another way: If you invested in the S&P 500 stocks and ignored your investment for any five-year period between 1871 and today, you had a 90% chance of making money.
Longer time periods for investing make the likelihood of coming out ahead much greater. Investing in the S&P 500 stocks for a ten-year period, over the same time period, would have resulted in a gain about 97% of the time. For twenty-year periods, you would never have lost money. In fact, the worst outcome over any twenty-year period would have seen you earn 2.05% on average each year. (The best outcome over a twenty-year period—in case you’re wondering—has been a 17.95% annual return.)
“Past performance is no guarantee of future results.” There’s no denying the accuracy of that phrase. But investing over a longer time horizon is one effective tool to potentially reduce risk of loss.
Sources: Annual Returns on Stock, T. Bonds and T. Bills: 1928 – Current, pages.stern.nyu.edu; S&P 500 Historical Return Calculator, dqydj.com.