Playing the Averages

Posted By T. Lee Sherbakoff, CPA/PFS, CFP® on Jul 2, 2021


“Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”
— Paul Samuelson, first American to win the Nobel Memorial Prize in Economic Sciences

If you walk into a casino and put your money on the table, the odds are stacked against you.  You are likely to lose no matter how exciting it might be.  If you flip a coin, there is a 50-50 chance you’ll get heads.  If you purchase a broad-based, diversified stock market index at the beginning of the year, historically, the odds have been in your favor.

Regardless, we rarely recommend an all-stock portfolio.  There’s too much risk of shorter-term volatility. For others, income may be the primary consideration, rather than capital appreciation. Put another way, our recommendations are customized to your long-term financial goals and preferences.

However, if we look back at the data over the last 60 years, stocks have been an excellent vehicle for individual investors to create wealth.  The S&P 500 Index has risen 47 years and has fallen 13 years (total return, dividends reinvested 1960–2019).  That’s an impressive performance that covers rising and falling inflation, rising and falling interest rates, wars and peacetime, and several expansions and recessions.

But returns have varied by a wide margin.  Over the last 60 years, when the S&P 500 Index finished the year lower, the average annual decline has been 12.9%.  The range of the annual decline: -3.1% to -37.0%.  Yes, there are times when the optimistic bulls are beaten up.  When the S&P 500 Index finished higher, the average annual increase has been an impressive 18.6%. The range of the annual increase: +1.3% to +37.6%.

There will be times when the outlook sours, but as we’ve seen time and time again, the U.S. economy has recovered and gone on to new highs.  We know stocks can be unpredictable over a shorter period.  While they are sometimes unpleasant, sell-offs are normal.  But we take precautions to minimize volatility and, more importantly, keep you on track toward your financial goals.

We view a well-diversified portfolio as the economic equivalent of purchasing a stake in the U.S. economy. We don’t know if the economy will be larger next year, but over a long period, the U.S. economy has expanded. We see it reflected in long-term stock market performance.

You might recall a comment by the legendary investor Warren Buffett.  “For 240 years it’s been a terrible mistake to bet against America, and now is no time to start. America’s golden goose of commerce and innovation will continue to lay more and larger eggs.” 

As we’ve emphasized in prior conversations, stocks have a long-term upward bias, and that upward bias is incorporated into your financial plan.  But stocks don’t rise in a straight line.  Since 1980, the average annual intra-year pullback in the S&P 500 has been 14.3%; yet, the S&P 500 has averaged a 13% advance each year, including dividends.  Last year’s pullback was 33.9%, while last year’s total return for the S&P 500 Index, including dividends, was 18.4%.

What this tells us is that a diversified portfolio of stocks has a place in most of the financial plans we recommend.  We may recommend a larger or smaller allocation of stocks based on many different variables.  But in most cases, equities are an integral component of a portfolio.  Over your investing lifetime, understand that you will experience a long life of potentially superb equity returns punctuated often by genuinely horrific volatility.