Trading Tips No 2: The Big Lie in the Stock Market

 

It is commonly reported that the stock market averages about 10% per year return over the long term (decades). So the investor that buys and holds a diversified portfolio of stocks or mutual funds is led to believe that their portfolio will grow by 10% per year on average. You know the mantra, “Not to worry, I’m a long term investor. On average, I’m earning 10% per year.”

There is only one problem here. The facts, as you will see in a moment, state otherwise.

Let’s assume for a moment that an investor could match the stock market average return of 10% per year (not likely, by the way, as most professionals fall short of this goal). Further assume the market averages 10% per year over a four year period:

Year - Ac Size - YR Return - Av Return - Av Return

0 $100,000

1 $ 80,000 -20% -20% -20%

2 $ 72,000 -10% -15% -14%

3 $ 93,000 +30% 0% -2%

4 $131,040 +40% 10% +7%

From the above example, you can see that our investor who managed to match the stock market performance year by year finished with an average portfolio return of only 7%, not 10%. Underperforming the stock market averages will always be the case, no matter what market period is selected - past, present, or future. So, can you expect to average 10% a year in a diversified portfolio of stocks and mutual funds (that you buy and hold) in a market that averages 10% per year? The answer is clearly, “No!”

This is one reason for considering alternative investments for a portion of your portfolio, such as a good trading system that provides superior returns in non-correlated markets.

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