Call it the Great Pacifier of Investing. Long term, common stocks produce an average return of just over 10 per cent a year. Better still, the longer you hold your investment, the greater the probability it will provide the long-term average return.
All of which is true and deeply tranquilizing.
Unfortunately, it doesn’t mean much in real life.
It turns out that there are gigantic gaps between theory and practice because you and I don’t make one investment, once. Instead, we make a multitude of small commitments over a long period of years.
The fact that we make our investments serially can bring shockingly different results. I learned this while using a software and data package called WAT$. Jaye C. Jarrett, a San Antonio investment advisor, developed the software. The software allows you to put together different programs of accumulation (or distribution) from any portfolio you design and calculates the results, in dollars, over any and all selected time periods. Unlike virtually all other such programs, Mr. Jarrett’s’ calculates actual year-by-year results. Most programs simplify calculations by using average annualized results over the same period. Mr. Jarrett’s’ program does both calculations, allowing us to compare the difference. I’ve seen no other program that does this.
To explore the consequences of actual results investing, I designed what might be a typical saving pattern for a modern worker— 10 percent of salary. (This isn’t as heroic as it sounds. Most people can do this in a 401(k) plan if they save just over 6 percent a year and enjoy a 50 percent employer match.) The amount saved grows at 4 percent a year, with salary, and the saving period is 30 years. Beginning with a salary of $30,000, the worker will have a final salary of $97,302. I also assumed the worker was a Couch Potato investor, putting 75 percent of his savings into large company stocks and 25 percent into intermediate government bonds.
Then I asked the program to calculate the results for every 30-year time period between 1926 and 1998, a total of 44 periods.
The printed results were shocking. Even though we were investing the same amounts in the same assets and rebalancing the portfolio in the same, consistent 75/25 mix at the end of each year, the long-term results varied wildly. They ranged from a lovely $1,583,230 for the 1969-1998 period to a miserable $458,298 for the unfortunate 1945-1974 period. That’s a spread of more than a million dollars!
But that wasn’t the end of the surprises.
The lowest annualized rate of return on the portfolio, from 1929 to 1958, was a meager 7.65 percent. If you calculated the results using that figure, you would have accumulated only $502,210. But if you calculated the results using actual market returns from year to year, you had accumulated $917,718— nearly twice as much.
It happened again using the highest annualized return for the period, 1969-1998. If you used the 11.84 percent annualized return you would have accumulated $1,032,660. But if you did the same calculation using actual results, year by year, you accumulated $1,583,230— a difference of more than half a million dollars.
Now look at the different market results for 8 different periods with very similar annualized returns. In eight periods, the annualized returns ranged from 8.75 percent to 8.92 percent, a tiny amount. Calculated using those constant returns, the range of results was just as narrow— $602,295 to $620,425. When the calculations were made on a year-by-year market return basis, however, the range was far wider— from $458,298 to $909,864. You could accumulate more than what the average annualized rate figure indicated, or you could accumulate less than the average annualized figure indicated.
What you got depended entirely on what happened, year by year, during your thirty-year accumulation period.
Reality Check on Annual Investing
| Time Period | Annualized Return | $ By Annualized | $ By Market Return |
| 1945-1974 | 8.75% | $602,295 | $458,298 |
| 1955-1984 | 8.75% | $602,965 | $600,644 |
| 1952-1981 | 8.79% | $606,757 | $503,000 |
| 1946-1975 | 8.80% | $608,092 | $541,920 |
| 1927-1956 | 8.82% | $610,120 | $840,651 |
| 1937-1966 | 8.85% | $612,789 | $821,461 |
| 1956-1984 | 8.91% | $618,809 | $713,278 |
| 1931-1960 | 8.92% | $620,425 | $909,864 |
Source: WAT$, Jaye C. Jarrett
What does this mean to you and me?
Our retirement plans aren’t just a plug-in computation. The unwritten history of our future, with all its uncertainties, is still the main event.
Photo: Nattanan Kanchanaprat from Pixabay
(c) Scott Burns, 2022