According to Ibbotson Associates, a well respected data mining firm, since 1926, U.S. stocks have returned on average 9.8% per annum. This is the compounded annualized total return (i.e. including dividends that are reinvested) of the S&P 500. Over the same period, bonds, which is the other major asset class has returned 5.3%, significantly less than equities. Taking the more recent past such as the last 10 years, however, the results are -2.22% and +6% for equities and bonds respectively, in stark contrast to the longer term where the equity investor was the clear winner. These results tell us that although we can expect average returns in the order of 9.8% over the very long term, we can experience significantly long periods (a decade in this example) where average returns could turn out to be substantially below this figure.
This example illustrates well the importance of diversification amongst asset classes because although even for a diversified portfolio, correlation aberrations over shorter term periods such as in 2008 can lead to significant losses, over the longer term they are likely to be diluted somewhat.
Coming back to the 9.8% return expectations drawn from data that spans over a very long period, it is not very realistic to expect such returns into the future, particularly in an environment of weak consumption, investment and greater fiscal discipline. To make matters worse, the Ibbotson figures happen to be gross of inflation (average 3%), investment expenses (average 1-2%) and taxes (average 1-2%) which means that if we were to calculate the net expected annualized total return for equities, it would add up to between 2.8% (worst case) and 4.8% (best case). You may argue that inflation is a non issue because we haven't seen much of it over the past decade, but the future may turn out to be very different given the quantity of stimulus out there. In any case what is clear from the above is that to be able to generate a decent return over coming year is going to require a lot of skill that only true professionals can provide.
