The Anna Maria Island Sun Newspaper

Vol. 15 No. 17 - February 18, 2015

BUSINESS

Anna Maria Island Sun News Story

Beware of average expectations

Investment Corner

In the world of investments, there are expectations of a reasonable return the investor should realize for the risk taken on the investment. These expectations are generally formed with an eye on history used as a guide to the future. It may not be perfect, but it’s pretty much all we have to go on. For example, the expectation that most investors have about the return potential for stocks is an 8 to 10 percent per year average over long periods of time with price appreciation and dividend income included. However, history shows that there are many more years where returns are above or below average than in the average range.

In other words, our long-term expectations are developed through a wide disparity of short-term returns, both positive and negative, that more often than not, fall outside of our definition of normal. To analyze this the chart below takes expected return of about 10 percent per year and defined a band of +5 percent and -5 percent around that expectation. So, a return between 5 percent and 15 percent for a particular year would be considered normal. Returns further away from normal are grouped into 10 percent bands, both in the positive and negative direction.

The results are surprising. Since 1950, there are far more years where the S&P 500 had total return results outside of the normal range than in the middle band surrounding the norm. In fact, only 23 percent of these years, about one out of every 4, fell in the normal band.

The danger of expecting average returns each year is that we become disappointed when the below average returns occur and may be driven to make changes to our investment plan. These changes, of course, are usually made at the wrong times creating a sell low and buy high process, which does not help the bottom line.

Investors expecting to earn 10 percent a year from their equity positions over time should be prepared for results on a yearly basis that are abnormal. While 2014 turned out to be a year in which returns for the major stock indexes were in that normal range, with the S&P 500 Index providing a total return of about 13.6 percent, most years won’t fit the definition of normal.

2014 was unusual in some other ways though. There was a wide disparity in the returns achieved by sub-categories of different asset classes. For example, large cap stocks in general posted returns of over 10 percent, but smaller companies struggled this year after leading the markets higher for the two previous years. The S&P 600 Small Cap Index had a total return of just over 5 percent.

International stock markets, including emerging markets struggled and provided negative results for the year. At some point in the future, the domination of U.S. stocks will reverse, but there doesn’t seem to be any indication yet that this trend change is imminent.

Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing. Visit www.breitercapital.com.

 


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