Abnormal Averages

Given the number of young readers, today’s topic is incredibly important. Yes, this topic goes hand in hand with the idea of staying invested for the long term. Many people in the finance world have gone out of their way to make this point, so let’s add one more. 

Throughout a lot of my previous pieces, I have spoken of the S&P 500. This is an index of large-cap, US stocks (companies must have a market cap of over roughly $16 billion to be added to this index). This index in particular is market-cap weighted. This means the larger the company, the more weight the company is given in the index. 

Now that we are all on the same page regarding the S&P 500 index, or what most professionals refer to as “the market” let’s discuss the average return. The S&P 500 has returned roughly 10% per year over long periods. This is great, right? Well, yes, if we have a very long span of time to invest. 

But that average comes from decades of returns. Some of the years that are included in that average are negative and in 2008 alone, the S&P 500 posted a 38% LOSS! The point I want to emphasize for young professionals is that, while yes, the index has produced an average return of 10% annually over long periods, DO NOT count on it producing a 10% return often. Actually, it is incredibly abnormal to see the S&P 500 post a 10% gain in any year!

See below, a chart from macrotrends that illustrates the annual return for each of the last 29 years: 

S&P 500 Historical Annual Return Year by Year 1995-2024:

This is incredibly important to be aware of, especially for those of you who do not track markets or follow stocks regularly. When people discuss the average return be sure to note that they are almost always referring to the long-term average. As the data above shows, the years in which we post a 10% gain are few and far between. However, when I calculated the average over those 29 years (2024 does not count as we just began), I got nearly 10% on the nose.

When it comes to young professionals, we have long time horizons. Time is our greatest asset. While the market tends to be volatile on a year-over-year basis, sticking to our plan will likely allow us to achieve the long-term average annual return that is so highly sought after. 

PS: This is exactly why financial professionals will tell you not to invest funds that you wish to spend in the near future. Imagine in 2008 you wanted to purchase a house in a year and lost 38% of the funds you had earmarked for that purchase… When dealing with short-term time horizons, there is usually no reward worth the risk of investing your funds. 

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