Growing up in school, no one wants to be average. From the start, averages are ingrained into us, and behaviorally, we always want to be better than average in everything we do. Take this question: Are you an above average driver? My guess is you’d answer yes. And I’d venture to say that more than 50% of you answered yes. Yet that’s impossible to be true. For average to be average, 50% of you should say yes, and 50% should say no. But we have a bias that we all think we are better than average.
In certain cases, averages can be helpful. But in others, they can be distracting or even downright annoying. Take investment returns as an example. You’ve heard us (and likely countless others) talk about the long-term average returns of stocks having been 10%. Once an average is identified, our minds anchor to it. So, if this year happens to be getting 10%, you feel good. If it’s worse than that, you feel bad. However, if you look at the data, which you can see below, average returns are rarely captured in a year.
S&P 500 Index Annual Returns 1926-2018
This chart shows yearly returns for the S&P 500 Index since 1926. The shaded gray area is the historical 10% average plus or minus 2%. Of the 93 years of data shown, only 6 of those dots land in the shaded area. That indicates that just 6% of the time, returns have been “close” to average. 94% of the time it was different, oftentimes widely so. That doesn’t feel average at all.
The reality of averages is they can be helpful looking at returns over a really long period of time. So, for long-term financial planning and cash flow analysis, their relevance goes way up. Just look below:
Over short periods of times, the difference in one-year returns we have seen in the market are huge! However, if you look over longer periods of time, that dispersion gets tighter and tighter to the average.
Although averages surround us, it’s important to remember the context of how they are created. Time helps achieve averages, but when time isn’t there, doing more important and in-depth work of understanding how things are doing on a relative basis is much more relevant.
One place where averages may be helpful is if you’re trying to condition yourself to the idea that things happen more frequently than you think. A recent Wall Street Journal article1 touches on this where it discusses that since 1896, the Dow has fallen by at least 2% in a single day 1,011 times. That averages out to once every 33 trading days. To take that average and apply it to today’s levels, you should expect the Dow to fall by at least 500 points every six weeks or so. While not fun, that type of average is good to prepare for.
1 Wall Street Journal 5/17/2019, “Mr. Market Just Got Inside Your Head. Don’t Let Him Mess With You.” Jason Zweig
S&P 500 Shiller Composite – The S&P 500 Index includes a representative sample of the largest 500 companies in the U.S. Robert Shiller did slight modifications to this data to get longer-term numbers. His data can be found at www.econ.yale.edu/-shiller/data.htm
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