The last two years have been a see-saw ride in the markets. The S&P 500 dropped nearly 20% in 2022, only to climb back up 24% in 2023! For those who had all of their money invested in the index, this recovery nearly brought their balance back to the breakeven amount ofthe beginning of 2022. Note: they would have needed a 25% return after losing 20% to fully recover.
A thirty percent return is an achievable feat for one year if you’re aggressive enough (and shall I say lucky enough), AND have the stomach to ride out the volatility, but consistently performing year after year becomes an incredible challenge that no one to my knowledge has done. Let’s take a closer look at the numbers from the last decade using the Quilt Chart below.
Each colored square represents a different market sector or style. For example, the top left purple square is U.S. REITs (Real Estate Investment Trusts) and was the top performer in 2014, but the bottom performer in 2020. If you invested all of your money in this category in 2014, you would have achieved a 30% one-year return. However, the next year, 2015, no asset class as a whole reached 30%. The same in 2016. Eventually in 2017, EM (Emerging Markets) was up 37.3%. You can already begin to see the trend that the same color square is not consistently at the top. Furthermore, the top player doesn’t always return 30%.
Now, looking closer, you’ll see a white square labelled Diversified Portfolio, which was up 15.1% in 2017. This Diversified Portfolio represents a mix of stocks and bonds, approximately 60% stocks and 40% bonds and cash. The more you look at this chart, you’ll notice that the white square is consistently found in the middle area year after year, producing a less volatile return. Connecting the squares of the same colors, you can visualize the emotional see-saw ride you would be taking from year to year. Want a sturdy, more sustainable ride? Connect the Diversified Portfolio squares.
This historical data reveals an average annual return of roughly 5.5% in a diversified portfolio of stocks, bonds, and cash and 12% if
you were all in U.S. large cap stocks. While this represents respectable growth over time, it also accounts for fluctuations experienced annually. Aiming for a 30% return necessitates venturing far from established benchmarks, venturing into riskier and less predictable territory. This often involves concentrated bets on individual stocks or volatile sectors, exposing you to the potential for substantial losses, negating even slight gains. The graph shows examples of yearly returns of single stocks or indexes that are well over 30% for a single year but would require the nimbleness of buying and selling each year – from one investment to the next, never getting a year wrong, which is often referred to as market timing.
Looking at the annual individual stock returns above, one might conclude that a yearly 30% return over the past 10 years could have been achievable, or at least in part, by picking the winning stock year after year and consistently clearing a 30% a year hurdle. Achievable? Yes. Realistic? No. Let’s explore why.
In this example we are using historical data rather than projected data. Just like someone may think that they should have known who won the Superbowl before it happened, but only realizing this after it has come to fruition. This is called Hindsight Bias – or, I should have known it all along. Hindsight bias is the psychological phenomenon that allows people to convince themselves after an event that they accurately predicted it before it happened. This can lead people to conclude that they can accurately predict other events. Read more about “expert” predictions in our blog posts: Has the Easy Money Been Made? The Challenges of Predicting the Stock Market. & From Tea Leaves to Talking Heads – The Price of Timing the Market.
The quest for outsized returns inevitably requires embracing outsized risks. The challenge with trading stocks to make your predictions pay off is that you must be correct not just once, but twice – when to sell and when to buy. Additionally, the decisions on what to sell and what to buy must also be correct. Strategies like leverage, where borrowed capital amplifies gains and losses, or investing in highly speculative assets, might entice with the promise of 30%, but the odds of incurring devastating losses are significantly higher. The emotional toll of such volatility can be immense, potentially leading to panicked selling at inopportune moments, further jeopardizing your financial well-being. Even the most seasoned investors struggle to predict individual stock performance with such accuracy. Market anomalies and unforeseen events can quickly derail well-crafted plans, leaving you chasing returns that remain elusive. Focusing on unrealistic targets can cloud your judgment, leading to impulsive decisions based on hope rather than sound analysis. Read how Your (Mis)Behavior Can Break the Bank.
The allure of a 30% annual return in the stock market is undeniable. It conjures images of rapid wealth accumulation and financial freedom. However, reality paints a far less rosy picture. While achieving such returns might seem feasible on paper, several fundamental factors render it an impractical and potentially perilous pursuit. Even the most complex mathematical algorithms designed by Wall Street wizards have not been able to achieve these consecutive returns.
Instead of fixating on unattainable gains, adopt a long-term perspective. Diversify your portfolio across asset classes, minimizing exposure to excessive risk. Remember, even a 5-10% annual return, compounded over decades, can yield significant wealth. Seek professional guidance from a fee-only fiduciary RIA and remain grounded in realistic expectations. The stock market offers numerous opportunities, but chasing unrealistic returns is a gamble best left untaken.
Editor’s note: This post was originally published in November of 2014. It has updated for depth and to reflect today’s data.
Sources:
https://www.netcials.com/
https://www.simplypsychology.org/cognitive-bias.html
https://www.schwabassetmanagement.com/content/quarterly-chartbook-video
https://investor.vanguard.com/investment-products/etfs/profile/vug#performance-fees
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