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Weekend reading: Normal returns in the stock market aren’t normal

Weekend reading

Some good reads from around the web.

When people discover my interest in investing, they usually express mock  horror, and ask me why the past few years of turmoil hasn’t caused me to find a new hobby and/or stash my cash under the mattress.

Partly because the last few years has been a great time to make money in the stock market, I reply.

That usually gives them pause.

Am I special? Not really. According to Morningstar, an investor in the FTSE All-Share index reinvesting dividends via this HSBC tracker would have enjoyed an annualised return of 13% over the past three years. That’s good enough to turn £1,000 into £1,444.

Of course, not all periods in the stock market are so fruitful. Over five years the annual return from the tracker is a big fat zero. Over ten years it improves to 5.47% per year, thanks to dividends.

But the past 3-4 years are definitely not a reason for concern.

What’s more, whereas some friends are horrified when they learn I’ve been regularly putting money into a market they believe has gone nowhere for a decade, I’m more horrified that they’re haven’t.

What is an average year, anyway?

Of course, I understand why they’re worried about my sanity. The financial news and the mainstream media are synonymous nowadays, with even the humblest BBC update not shy of mentioning a sharp fall in the indices.

I hear Robert Peston is so aggrieved, he’ll no longer get out of bed for less than 5% off the Dow.

Yet the volatility of recent years is not unusual – a point well made by Canadian Couch Potato this week:

You may be shocked to learn that a portfolio with equal amounts of Canadian, US and international stocks would have posted returns between 6% and 11% exactly five times in the last 42 years.

Think about that: in any given year, the chance that stock returns will be within this “normal” range was less than one in eight.

Now let’s consider the probability of more “abnormal” outcomes. If the average long-term return for stocks is 8.5%, let’s look at years where returns were a full 10 percentage points more or less than that.

It turns out that there were 11 years with losses of at least –1.5%, and 17 others with gains of at least 18.5%. In other words, the probability of a significant loss or a huge gain was 67%, or two years out of every three.

I don’t have the UK statistics to hand, but I am certain they are very similar.

Everyone who wants to succeed as an investor needs to get used to them.

From the money blogs

Mini-section about retirement

Buy of the week: Bored of bankers? Then set-up your own bank with your very own ATM machine. It’s designed to help you save money rather than spend it. That’s more than you can say for a modern bank.

Mainstream media money

  • BoE boss Mervyn King blasts ‘shoddy’, ‘deceitful’ bankers – This is Money
  • London: On a high – The Economist
  • Why everyone still wants to work on Wall Street – Business Insider
  • William Bernstein interview: The purpose of fixed income – Morningstar
  • Jeremy Grantham on investing today – CNN Money
  • Dividends key in a sideways market – FT
  • Buy with care, BTL landlords warned – FT
  • Exploring cash deposit accounts for SIPP investors – FT
  • What does the LIBOR scandal mean for you? – Telegraph
  • Homeowners pay off record amount of debt – Telegraph
  • Mortgages: How parents can help – The Guardian
  • What people really do when they work from home – Slate

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{ 16 comments… add one }
  • 1 timarr June 30, 2012, 9:42 am

    I don’t have the UK statistics to hand, but I am certain they are very similar.

    Yep. A quick eyeball of the Barclays Equity Gilt Study shows that the annual return on UK equities since 1960 has been 10% greater or less than 8.5% slightly over two-thirds of the time.

    Up years outnumbered down years by nearly 2 to 1.

  • 2 ermine June 30, 2012, 9:45 am

    Shouldn’t we also knock off 9% from that 13% result due to the outragously lax attention to inflation we’ve been having as the BoE tries to lose the debt (3%p.a. 2008 to 2011 according to the Bank of England), or is that the real return on the FTAS?

  • 3 The Investor June 30, 2012, 9:48 am

    @Ermine — That’s 13% per annum. (I am presuming you’ve multiplied 3% by three, for the three years?) The real return would be about 10% per year.

    @timarr — Thanks for doing the eyeballing!

  • 4 OldPro June 30, 2012, 1:00 pm

    “I hear Robert Peston is so aggrieved, he’ll no longer get out of bed for less than 5% off the Dow.”… bravo!

  • 5 ermine June 30, 2012, 3:21 pm

    @TI quite right. I must’ve misplaced the on-switch on my brain this morning 😉

  • 6 Alex June 30, 2012, 3:44 pm

    1. I enjoyed Rick Ferri’s profile of Charles Ellis. However, I did smile at the final sentence: “I was honored when Dr. Ellis wholeheartedly endorsed my latest book, The Power of Passive Investing.” I suppose it is Ferri’s blog and he has books (amongst other things) to sell. 🙂

    2. The Investor, I raised an issue in response to your round-up last weekend: the FTSE Emerging Index vs. the MSCI Emerging Markets Index (5th comment on your post). I didn’t receive any responses, so I hope you don’t mind me repeating my request for comments. Thanks in advance.

  • 7 The Investor June 30, 2012, 4:10 pm

    @Alex — Ah, yes, I was hoping The Accumulator might answer that one. I don’t really have a super-fine tuned Geiger counter for optimal index choice, to be honest, and a pretty cavalier attitude towards regional allocations, which I tend to shunt about with my perceptions of value.

    For instance, currently I am exposed to emerging markets via a long-term holding in the Templeton Emerging Markets investment trust, a recently repurchased stake in the Hansa investment trust, and L&G’s relatively expensive tracker. I have held the iShares EM ETFs in the past, too, as well as JP Morgan’s income orientated EM trust (Ticker:JEMI) which I have sold because I am scared of its popularity and the constant issuing of new shares.

    In short: I didn’t think you’d like the look of my answer much, so I decided discretion was the better part of helpfulness. 😉

    Perhaps T.A. will come along with a view soon.

  • 8 Alex June 30, 2012, 4:44 pm

    The Investor, thanks for that. As a general point, I find it strange that fund managers don’t routinely explain their choice of index to track for a given sector. It’s obviously a key consideration for a tracker.

  • 9 Ash @ Sterling Effort June 30, 2012, 5:04 pm

    Mock Horror?! Some people look at me in ACTUAL horror. Especially when I tell them some of my holdings are down 25% and I’m fine with that. It’s always good to remind ourselves that looking at such short time frames is meaningless. Oh, and thanks for the link love 🙂

  • 10 Paul June 30, 2012, 6:52 pm

    @TI,

    The comparison of the 3yr and 5yr returns nicely illustrates the meaningless of headlines based on two random dates. True passive investors use cost averaging (and that is how funds for investment usually become available). This automatically pulls the returns towards the long term average.

    Personally I think some degree of market timing is possible on a macro basis but, heh, we all have our weaknesses.

  • 11 Paul July 1, 2012, 6:19 am

    @TI, Further to my post above I thought I would put my spreadsheet where my mouth was and try and justify the point about the effect of cost averaging compared with two point numbers.

    I looked at the period 2000 to now (a pretty challenging period, I think you will agree. The following is based on S&P500 data (after Shiller).

    Index (real, without divs) -27.7%
    Index (real, divs reinvested) -9.6%

    I then considered the case of someone who invested on a regular basis each year, starting in 2000, and calculated what the portfolio would be worth today.
    Portfolio (real, divs reinvested) +12.9%

    13% isn’t much (although note the money has only been in the portfolio for 6 years on average) but it has at least it has comfortably beaten inflation, and in the worst bear market since Noah.

    Hope that helps……

  • 12 The Accumulator July 1, 2012, 8:15 am

    @ Alex – It’s been a long while since I looked into this and, off the top of my head, I can’t remember any differences that really stood out as information worth acting upon. Factors such as fund cost, tracking error and index replication are higher up the agenda for me. They are easily measurable and I can come to firm conclusions about their likely impact on my success. Here’s a link to a piece on measuring tracking error: http://monevator.com/2012/02/28/tracking-error-how-to-measure-it/
    You raise an interesting point though and I think I’ll take a look at this in more detail in a future post.

  • 13 RetirementInvestingToday July 1, 2012, 9:35 am

    Hi TI

    “Of course, not all periods in the stock market are so fruitful. Over five years the annual return from the tracker is a big fat zero.”

    That’s when a nice diversified strategic asset allocation combined with a bit of tactical bravado comes in. I don’t have exactly 5 year data to hand but I do have my portfolio since the 6th of January 2007 which shows £100 turning into £127.

    Cheers
    RIT

  • 14 Alex July 1, 2012, 11:01 am

    1. The Accumulator, thanks, as ever, for the response.

    2. I understand your point, but the factors you [rightly] cite as influencing your choice of passive fund PRESUPPOSE that your list of potential funds in a given sector all track the same index. If not, you wouldn’t be comparing like with like.

    3. I think we have to look more carefully at the indices we want to track. The FTSE Emerging Index and the MSCI Emerging Markets Index both describe ‘emerging markets’ (whatever they are) – but are defined quite differently. Here choice of index to track is important.

  • 15 david stuart July 1, 2012, 3:09 pm

    it amazes me how many high profile fund managers vilify pound cost averaging

    great post as ever the investor

  • 16 gadgetmind July 1, 2012, 6:26 pm

    Best post for a wee while, and I’m sure every long-term investor will have experienced the slack-jawed amazement that cash hogs adopt when you tell them that you’re investing in “the stock market”.

    Last summer I told a few people I was buying high-yield blue chips at bargain basement prices and they suggested I might like to look at the news, see the fires, and witness the blood in the streets.

    As of end of play Friday, my fledgling HYP is up 10% on capital and I have trousered 4% in dividends.

    I’m been buying European equities lately, mainly ITs holding solid European powerhouse companies but with huge discounts to already depressed prices. JEO is up 10% since I bought and others are showing promise.

    It’s when the markets are doing well, and everyone wants to big in on the game, that things become hard. Do you ride the momentum or dynamically rebalance into whatever everone else is shunning?

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