Stocks earn high returns and have high volatility compared to bonds. Investors can earn stocks' high returns while avoiding the majority of stocks' high volatility by selecting an appropriate holding period
1. Stocks’ annual returns
Figure 1 charts the annual returns of the US stock market for the prior 95 years. The average annual return is about 12% and returns vary widely from year to year and are negative in 25% of years.
Figure 1 - U.S. stock market returns 1927 to 2021—one-year holding period.
2. Stocks’ five-year average annual returns
Figure 2 shows the average annual returns for rolling five-year holding periods. Comparing Figure 2 to Figure 1, we see a dramatic decline in return volatility. Average annual returns of five-year holding periods vary substantially less than the returns of one-year holding periods and are negative in only 8% of five-year periods, with three-quarters of the negative returns occurring during the years of The Great Depression.
Figure 2 - U.S. stock market returns 1927 to 2021—five-year holding period.
3. Stocks’ ten-year average annual returns
Figure 3 plots the average annual returns for rolling ten-year holding periods. A comparison of Figure 3 to Figure 2 shows a further decrease in return volatility and average annual returns are not negative for any ten-year holding periods.
Figure 3 - U.S. stock market returns 1927 to 2021—ten-year holding period.
4. Conclusion
The data indicate that as we lengthen the holding period, the volatility of the average annual holding period return decreases dramatically. Intuitively, the longer the holding period, the greater the opportunity for good years to offset bad years.
Between 1927 and 2021, U.S. bonds returned an average of about 6% per year while U.S. stocks returned about 12%. The main message is investors can earn stocks’ high returns while avoiding the large majority of stocks’ return variability by selecting a sufficiently long holding period.
Dr. Andy Lawson is the principal of Freshfield Investments, a Registered Investment Advisory firm in Plano, Texas serving clients locally and nationwide. Freshfield provides investment management and financial planning as a fee-only, fiduciary. To book a virtual or in-person complimentary consultation, please visit our Contact page.
Data source: Kenneth R. French Data Library, Tuck School of Business, Dartmouth College
My thanks to David Welch, Citibank and Alexandra Neff, Bank of Texas
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