Historically, the stock market has been able to deliver around 10% annual returns on average.
The key word when thinking about that, however, is "average." Rarely will you ever see the S&P 500 climb an even 10% in a given year. This 10% is determined by averaging years that have experienced returns much better than 10% as well as years that are much worse or even negative.
Ultimately, it's a mistake to think stock prices just go up, uninterrupted by downturns.
Bank of America Merrill Lynch's Savita Subramanian shared a chart that does a pretty nice job of illustrating the roller-coaster ride that stock market investors actually experience.
She reviewed 12 major S&P 500 peaks since 1930 and averaged the price performance during the months leading into the peak and the months after.
So as much as stocks tend to go up, they frequently also go down sharply. But those downturns are also followed by recoveries. And on net, the patient investor ends positive.
To be clear, this is just a summary of what has happened in the past around market peaks. In between these events are long periods of lackluster action in the markets. Having said that, there are a couple of things to take away from Subramanian's research:
- Returns are very strong in the months leading up to a peak. The median returns in during the six months and 12 months before a peak were 14% and 21%, respectively. An investor seeking gains probably wants to be part of that action.
- Declines after a peak are bad, but they don't offset the gains. The median returns in during the six months and 12 months after a peak were -12% and -15%, respectively.
- But even after the violent sell-offs, markets recover losses in two years. The median return 24 months after a peak is -1%, meaning that most of the losses seen in the six-month and 12-month periods are recovered for patient investors. If anything, downturns are opportunities for investors to buy more and lower their average costs.
Attempting to time the market (i.e., trying to perfectly sell at the high and then buy at the low) is usually a money-losing proposition for investors and traders. But the history — for what it's worth — shows that patient investors will at least be able to recover losses as long as they don't sell at the bottom.
