Week 7 Day 2: 10% Average, Not 10% Every Year

In the last 50 years, the S&P 500 has returned between +30% and -40% in individual years. Some years you gain a third of your portfolio. Some years you lose a third. But across decades, the average settles around 10% nominal (7% after inflation). The key word is 'across decades.' Short-term, anything can happen.

Here is what the 10% average actually looks like year by year: the S&P 500's annual return has been between +5% and +15% (the 'average' zone) only about 20% of the time. In other words, 80% of years are NOT average. Most years are significantly above or below average. Individual years: 2008: -37%. 2009: +26%. 2013: +32%. 2018: -4%. 2019: +31%. 2020: +18%. 2022: -18%. 2023: +26%. The actual experience of investing is a roller coaster, not an escalator. But the ticket price of admission to the 10% long-term average is enduring all those swings without panicking. If you sell during the bad years, you lock in losses and miss recoveries. The 10% average is only available to those who stay for the entire ride.

The distribution of S&P 500 annual returns approximately follows a normal distribution with a mean of about 10.5% and a standard deviation of about 16%. This means that roughly 68% of years fall between -5.5% and +26.5%, and roughly 95% of years fall between -21.5% and +42.5%. Annual returns exceeding +40% or below -30% are tail events occurring roughly 2-3% of the time. However, actual stock returns exhibit fat tails (excess kurtosis) and slight negative skew compared to a true normal distribution, meaning extreme negative events are more common than a normal distribution predicts. The practical implication: expect 1-2 years per decade where the market falls 20%+, and 1 year per decade where it falls 30%+. These are features of the system, not bugs. The 10% average return includes these crashes -- it is the price of the premium.