It’s amazing how one year can impact the annualized rate of return of a longer period of time. To see what I mean, take a look at the two graphics below. The first one shows the annual returns from 1987-2006 of the indexes represented in Callan Periodic Table of Investment Returns that I reference fairly often on this blog.
This graphic shows those same indexes from 1987 – 2007:
Now, this graphic shows you how 2007’s returns impacted the annualized rate of return (also called the geometric average) for the indexes:
As you can tell, last year’s mediocre performance dragged down the long-term annual average rates of returns for most of the indexes. The Russell 2000 Value Index was impacted the most as its annualized rate of return dropped from 13.64% to 12.40% due to the fact that index lost 9.78% in 2007. However, it’s important to remember that just as bad years will drag down average returns, good years will pull them up. In other words, it’s the long-term average that we’re after and not the short-term ups and downs.