Over and over again, we’ve all heard that – over the long-term, the stock market has averaged a respectable return – 7% in excess of inflation is often quoted. The problem with that concept is that averages don’t apply to individuals. When we consider what makes an average, we see that there are data points above and below the average. For example, while the average temperature for a region may be 75 degrees, there may also be times when in that same area the temperature is 8 degrees,and times when it is 108 degrees.
The same is true with the stock market. There have been extended periods of time when the market has under-performed the average, and times when it has over-performed the average. Take a look at the image below.
The black diagonal line shows a 6.9% average gain from 1925 to 2012. The blue line shows real large-cap returns including capital gains and dividends. Notice the periods of time of under-performance and over-performance. Notice that some of these periods are extended.
Suppose that one of these extended periods of under-performance occurs in the 10 years preceding your retirement, and you’ll be able to see why averages don’t apply to individuals! You may have planned on a 6.9% overall average, and the market wasn’t kind. Notice the two large declines in the market since 2000. One decline was about 50%, and the other was about 57%. These two declines have caused the market to under-perform it’s long term average for the last several years.
Although no investing methodology is right 100% of the time, another investing approach is to over-weight investments in the stock market when it is performing above the average, and under-weight investments in the stock market when it performing below the average. Relative Strength investing is a methodology that does just that.
Chart provided by Dorsey Wright and Associates. The postings on this site are my own and do not necessarily represent Dorsey Wright & Associates positions, strategies or opinions. The information contained in this post is neither investment advice nor a recommendation or solicitation to buy or sell any security. You should consult an investment professional before making any investment decision.