The Range

"It is nonsense to say, "Common stocks have produced an average rate of return of 9 percent." This is an incomplete and misleading statement. Far better, we could say, "Over the past 50 years, the actual returns have been between a loss of 43 percent, and a gain of 54 percent. While the geometric mean rate of return is about 9 percent, the standard deviation of actual returns around that mean is nearly 22 percent. And finally, we regret to say we cannot give you the sequence with which those returns will be experienced. They, of course, occur at random." - Charlie Ellis

If more professionals spoke this language, investors would be better off.

It is for this reason that we run through 'range of return' scenarios with clients with help from our partners at Riskalyze. It is why we discuss 'stress testing' portfolios to show how they have held up in past environments. History doesn't repeat itself, yet still serves as a meaningful reference and reminder of what could come.

What is your breaking point as an investor? Tell me more about your feelings and behavior during the fall of 2008. Would you be moved to start reacting to market swings if your portfolio was down 15% three months from today? Do you know that your account, as constructed fell nearly 48% from October 2007 through March 2009?    

This particular portfolio shows a high likelihood (95% probability) that returns will be within -15% and 23% over the next six months. Quite the range of possibilities. 

Yet, it is precisely this vagueness that will help in preparing for more difficult times. And ultimately, the thing that matters most is how one handles their emotions when it gets hard. If your patience has been tested in 2018 because your portfolio is 'only' up 2%, it will be broken if the market goes down 20% within a few months (whenever that takes place.) And if it breaks, nothing else really matters.

So when all of the big brokerage houses and banks come out in December with their 2019 market forecasts, revisit the quote from Charlie. Understand that your success as an investor has nothing to do with forecasting and very much to do with staying invested over a long period of time. A better understanding of return possibilities along the way will help to ensure that the latter is executed on. Easier said than done.

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Sources: Winning the Loser's Game (Charles Ellis), Riskalyze Portfolio Report