There seemed to be a bit of confusion regarding yesterday’s Why the Long-Run is so Important When Investing in Stocks post. My goal with that post was to show that the long-run tends to smooth out returns (both negative and positive) and that investors who have a long time-horizon don’t really need to worry about the daily ups and downs of the market.
Here’s how I put that post together:
1. I took the indivdual yearly total returns for the S&P 500 Index as found in Ibbotson’s Stocks, Bonds, Bills, & Inflation.
2. Depending on the rolling period I was looking at, I simply took the geometric average of the real returns from that period. For instance, for the first 5-year period, which was 1926 – 1930, I used the following real returns (remember real returns are the returns minus inflation for that period):
3. Then, I took the next 5-year period (1927 – 1931) and performed the same calculation until all 5-year periods were calculated.
The end result was a bar chart that showed the average annual real returns for the various rolling periods.
Today I decided to look at TOTAL REAL RETURNS (or cumulative returns) for each rolling period. To illustrate what I’m talking about, take a look at the graphic from above. To calculate the cumulative return over that 5-year period, you simply multiply the factors together like this:
Now, you simply subtract 1 from that number and move the decimal 2 places to the right and you get 69.213% as the total real return for the 5-year period from 1926 – 1930. So, had you invested $10,000 at the beginning of 1926 and held it for the entire 5-year period, it would have grown to $16,921.30 by the end of 1930. Keep in mind that that number is real return, which factors in inflation.
So, here’s a look at the total real returns for 5, 10 and 20-year holding periods (you can click on each chart to see a larger version):