By now 2016 is far off in the mirror and everyone is focused on more current events, but I want to take us back a few weeks to reflect on the year that was, at least as it pertains to portfolio performance.
First, US stocks, measured by the S&P 500, finished the year up 11.96%, a wonderfully solid year. Long term average compounded returns for US stocks are in the 9-10% range (depending on how you’re counting), so this ended up being an average, slightly better than average year. Thanks to data from Aswath Damodaran at NYU, we know that the arithmetic average from 1928 is 11.42%, and the geometric average is 9.52%. So we’re right in the mix at just under 12%. And while that’s roughly average, average isn’t all that normal.
This chart shows how common each range of annual returns has been over the last 89 years, with intervals of 5%.
So you can see that we do get annual returns of 10-15%, but it happens about 12% of the time. We’re practically just as likely to get returns of 0-5% and returns of 25-30%, and nearly as likely to get returns of -10 to -15%!
What’s more, many diversified investors found that in 2016, their balanced portfolio landed quite close to what they might like to see for long-term results. An overly simplified portfolio of 60% MSCI All-World Ex-US and 40% Barclay’s aggregate bond returned 5.92% in 2016. For balanced investors looking for a 6-7% return, that ain’t bad! Of course, individual portfolios won’t look just like this, and varying allocations to real estate, small caps, emerging markets and changes in bond portfolio duration will affect returns somewhat.
The best thing about 2016 for diversified investors is that returns didn’t all come from the same place. We saw significant divergence among market, asset class and sector performance. Sure, US large cap stocks were up a nice middle-of-the-road number, but small caps (Russell 2000) were up over 21%, while developed foreign stocks (MSCI EAFE) were essentially flat at 1.5%, and bond returns were all over the map depending on credit quality and duration. Broadly allocated investors should rejoice, as this means that the broad idea of diversification is working. Some things (US small value, anyone?) we loved, others (Europe?!) we hated. Huzzah!
The other apparent risk from a year like 2016 for investors is complacency. I’ll admit, I heard very, very few calls after year-end reports went out. Nobody is complaining. “Finally, it’s working like it is supposed to!” But I gotta tell you – yes, 2016 is how it is supposed to work. But so was 2014, when diversified investors were disappointed at best. Or 2015 when anything outside of US stocks wiped out what meager gains were to be had. This is how it always works – returns are lumpy, not smooth. We don’t get to choose when they come, how they come, whether we’re excited first and disappointed later or vice versa. Being a long term investor means passing up convenient, predictable, steady returns. Lackluster markets can and will stick around longer than you’d like. So while we get to be thankful for a year like 2016, we don’t have the luxury of assuming we’ll see anything like that on a regular basis.