Current 1-year stock market returns look amazing. Who would choose any alternative investing strategy when their current method has granted them 40%, 50%, or higher 1-year returns?
Of course, there’s more here than meets the eye. And we need to zoom out to see it.
Amazing 1-Year Returns
Here’s a snapshot of the S&P 500 1-year return, as of April 7, 2021. It’s up 53.2% compared to last April. We are flying!
Hot damn! This return has amazing ramifications on stock portfolios. We’re normally told to assume that stocks will return ~7% per year (on average) after adjusting for inflation. This past year was seven times better than that.
Once we start compounding, the 53% return becomes even more amazing. Five years of compounded 53% return outperforms 30 consecutive years of 7% returns.
A few more years of this and we’ll all be retiring. Right? Right?!
Sad to say, the other shoe must drop. We’re missing something important.
One Year Is Never Enough
More data provides more clarity, and one year does not make a long-term investing data set. One year is never enough.
When starting from a market-bottom, the resulting returns are going to look phenomenal. It’s like analyzing an athlete’s year-over-year performance the season after he broke his leg. Of course he’s going to look better this year. His leg isn’t broken anymore!
April 2021’s 1-year return is especially egregious.
The stock market had a broken leg last April. COVID fear had traders flocking for the exit door, willing to accept lower prices as long as it meant they could liquidate their positions.
See that 4/20 red arrow?! See how the market had a broken leg last April?!
You don’t see that broken leg in the first graph today, the one that only showed 52 weeks. We have to zoom out to see that dip. We have to be willing to absorb more data.
If we look at a 60-week return (starting last February), the stock market is up 22%. That’s still very good! But it’s not 53%.
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Let’s zoom out further to the full 5-year return in the chart above. The market is up 99% since April 2016, or the equivalent of five consecutive compounded 14.8% 1-year returns. Again, that’s very good. But it’s significantly different than a 53% 1-year return.
If we keep zooming out, we get closer and closer to “truth.” Here’s the S&P 500 dating back to 1928, plotted on a log scale.
After adjusting for inflation (which is smart) and assuming dividends get re-invested (also smart), we conclude that the S&P 500 has historically returned ~7% per year.
You can pat yourself on the back for a 53% return if you want to. But be careful. Healing from a broken leg simply means you don’t have to limp for the rest of your life. That’s different than learning to fly.
We All Need to Zoom Out
That’s all I have to say on stocks for today. You can be happy that markets have recovered from last spring, but bragging about 1-year returns right now is foolish.
In parallel “zoom out” news…humans are notoriously bad at zooming out to long-term thinking. It’s one of my favorite pet topics. Here are a few good reads on that idea:
- A Lot Can Change in 10 Years
- The Market Crash is Coming!…Eventually
- 7 of My Money Mistakes…and the Lessons Learned
- 31 Lessons from 31 Years
That’s it. Short and sweet.
P.S. – If you enjoy podcasts, check out the Best Interest Podcast!