In a recent Wall Street Journal article Jason Zweig talks about the difficulty (and danger) of forecasting the stock market. I would recommend the article highly, but want to share a few thoughts.
Average Is Not Normal
We have been talking about this a lot lately. Because the market’s return has been right around 10%, we tend to define “normal” as any year that we get a return around 10%. We start to expect mentally, and we may even plan on (please make sure your financial planner is not doing this), getting 10% EACH year from money we invest in stock mutual funds. PLEASE understand that a 10% average return IS NOT THE SAME THING as a 10% return every year.
When we understand that most years the market return is nowhere near 10% we can begin to redefine “normal.”
If we can redefine normal, then we start to adjust our expectations.
When we adjust our expectations we might be less surprised when we are up or down a bunch (no surprise because “hey, it’s normal”).
If we are not surprised, then maybe we will not make some of the big behavioral mistakes like selling low, or refinancing the house to buy more when it’s high.
Average is Not Normal, my recent presentation I posted on SlideShare, explains this concept in more detail.
Market Timing and Forecasting is a COMPLETE Waste of TIME
Market returns come in very short and very violent bursts, both up and down. The rest of the time it is relatively boring. Zweig points to a new study that reaffirms something that good financial planners have been talking about for years. If you take the market return from 1900 to 2008, the average has been around 10%. Now get this:
- If you missed the 10 best days, you lost over 60% of the gain for the entire period. Ten days out of 29,694!
- If you managed to forecast the 10 worst days you could have TRIPLED your return!
Unbelievable.
As Zweig points out, “The moments that made all the difference were just 0.03% of history: 10 days out of 29,694.”
CAN ANYONE TELL ME WHEN ONE OF THOSE DAYS IS COMING?
The lesson is really this: if you want to earn the average return, you have to be in the market for the best days. If you want to be in the market for the best days, you are just going to have to live through the worst days as well. They come together.
(I love Jason Zweig, but it is really unfortunate that after laying out the case for not forecasting he felt the need to tell us one way to do it. Ignore that part of the article.)
