After a strong year for stocks, does it make sense for investors to dampen their expectations? That’s what many investors, professional or otherwise, were saying heading into 2014, following a year when stocks made new all-time highs and gained ~30 percent.
Looking at the data shows that stocks have actually performed better than average following an exceptionally strong year. Since 1901, there have been twenty-three instances that the Dow Jones Industrial average was up at least 25%. The average annual return following these periods was 11.8%, nearly 50% higher than the 7.9% average we have seen over the last 114 years.
There are a few other interesting facts worth mentioning about annual returns:
- Double digit returns are the norm, not the exception. Historically, the Dow is almost three times more likely to be up double digits than up single digits.
- On average, the Dow has returned 25% or more once every five years
- The Dow has been up double digits 48% of all calendar years.
The average annual return for all years is 7.3%, however it’s important to keep in mind that average returns and expected annual returns are two very different animals. Stock market returns don’t follow a schedule and have a tendency to be erratic.
Of the forty years when the Dow was negative, the average return was -15.3%. What’s important to understand is that a 15.3% gain does not negate a 15.3% loss. A decline of 15.3% requires an 18.1% gain to break even. The good news is that the average positive return is 19.4%. The better news is that the market has historically had positive returns nearly twice as often as it’s had negative returns. The takeaway is that patience has rewarded the disciplined investor who was able to sit through the bad times in order to enjoy the good times.