Are stocks looking more attractive now than they were about a year ago?
If you simply looked at the U.S. stock market’s five-year annualized performance ending on Dec. 31, it would be easy to assume that stocks have been on fire since the early days of 2009. On New Year’s Eve, the five-year annualized return of the broad U.S. stock market was a torrid 18.71%. A lot of investors will get excited about returns like that.
But wait a minute. Let’s check out the five-year annualized return of domestic stocks ending just a year earlier – on Dec. 31, 2012. If you use that time frame, the stock market’s performance over a half a decade looks dreadful. During this period, stocks only mustered a 2.04% yearly return.
So what happened?
By the end of 2013, the stock market could finally shake off 2008, which was a dreadful year for stocks, from its performance calculations. Wall Street was in the midst of a financial crisis in 2008 and stocks dropped by 37.31%.
The Vanguard Group created the chart below to illustrate how one extreme year on Wall Street can depress longer-term returns:
So what’s the take home message here?
Remember that stock returns, no matter what time period you use, are historical. You shouldn’t jump into stocks simply because returns happen to be currently high anymore than you should flee when equities are struggling.
Investors should create a portfolio with allocations to stocks, bonds and cash based on their time horizon and risk tolerance, rather than focusing solely on the latest return statistics.