What’s the average return you can expect on your investments?
Talking about averages can be tricky.
In every part of the country, you can find a statistic for average annual rainfall. The nation’s capital, for instance, receives an average of 70 centimetres per year. But this statistic can be very misleading.
Consider for a moment that on just one extremely rainy night in September of 2004, more than 135 millimetres of rain fell in Ottawa, skewing the numbers accordingly.
Clearly, the average annual rainfall figure isn’t always accurate. The bottom line: An average of any kind has little meaning if you don’t know the standard deviation, or variability, of the numbers that comprise the average.
The average returns of the stock market are similar to those documenting average annual rainfall. Depending on whose numbers you use, the S&P 500 index has returned, on average, close to 10% annually over the past 80 years. In any given year or shorter time period, however, your returns will vary based on market performance and asset allocation.
So, how do you determine what you might see in the future? There are no easy answers, but following a disciplined investment process and not chasing the latest investment fad will reduce the chance of buying investments at their peak value and thereby avoid crimping your potential returns.
It’s all about diversification. The S&P 500 has really offered only modest returns over last 10 years. Despite this, long-term investors have still been rewarded over time with more positive years than negative ones. But you still want to err on the side of caution when planning.
And remember, an investment in a total bond market index would have offered more positive returns over the same time frame, reinforcing the need for a balanced approach.
When planning for the future, I envision a 4% average stock market return. If I get closer to the 7 or 8% that I hope for, that’s great ... but I’m not going to count on that.
How conservative are you when looking ahead? What's your 'magic' number for future returns?
By Gordon Powers, MSN Money