There’s a lot of advice out there promising to deliver investment returns that beat the market. In a lot of cases this advice is coming from people who claim to have gotten themselves X return over Y period of time, and of course it’s always an impressive-sounding number. The personal stories can be incredibly compelling because they make it sound like it’s just an Average Joe out there dominating the investment world, so of course you could too.
There are many reasons to be skeptical of these people. The first of which is all of the data showing how unlikely it actually is to beat the market consistently over time. The second of which is that almost all of these people have no one overseeing their proclamations, meaning you have no idea whether they’re telling the truth or whether they even know how to properly calculate their returns. The third of which is that there’s almost never a real discussion of the risk involved with their investment strategy, which may be significant.
And then there’s the question of what their reported returns are being compared to. Often it’s nothing, with their return numbers being presented in a vacuum. Without any comparison, it’s impossible to decide whether their returns are actually worthwhile, or whether they’re just following the larger market trends.
What has the market returned recently?
Before you let yourself be impressed by someone’s reported returns, it’s important to have a benchmark for comparison. That benchmark will be different depending on how that person is investing. If they’re investing only in US stocks, then the US stock market should be the benchmark. If they’re investing internationally, then some kind of international market should be the benchmark.
But for our discussion today, that kind of precision isn’t all that important. For simplicity’s sake, we’ll look at the returns over the last few years for the US stock market, the US bond market, and a mix of the two.
The purpose of this exercise is to give you something basic to compare to when you hear someone proclaiming their latest and greatest investment results.
Recent US stock market returns
I’m going to use the mutual fund VTSMX, Vanguard’s Total US Stock Market index fund, as our measure of the US stock market. Here are the returns for the past few years:
The “Annual Return” and “Total Return” columns are just different ways of presenting your return over the period from the start of the year in the “Since” column through 8/22/2013. The “Annual Return” column presents the average yearly return of the US stock market. The “Total Return” column shows you the total growth of your money over that same period.
Recent US bond market returns
Now we’ll look at recent US bond market returns using the mutual fund VBMFX, Vanguard’s Total US Bond Market index fund:
Recent returns for a 50-50 stock-bond split
Now let’s look at how an investment portfolio split 50-50 between US stocks and US bonds has performed over the last few years:
How should we use this information?
These are not perfect comparisons for all investment strategies. Nor should they set any kind of expectations for your investments going forward. But they provide a starting point for you to be able to compare someone’s reported returns to a useful benchmark. If someone started investing in 2009 and is telling you they’ve gotten 15% returns in the stock market since, that might sound great compared to the historical average of 8.92%. But when you put it next to the 17.31% that the stock market as a whole has returned since then, it suddenly isn’t as impressive.
Providing information out of context is one of the biggest problems I see with a lot of the investment advice out there. When you’re reading or listening to something, it’s important to understand not only what the person is telling you but what they’re not. My hope is that the information here gives you a little more defense against investment sales pitches in the future.
Photo courtesy of Robson#