Understanding market history can be the antidote for financial failure. However, there is more. Comprehending the historical impact of inflation on wealth as well as your own financial history, rounds out the cure for failing financially. Conversely, ignoring (or misunderstanding) the markets, inflation and your history can provide a huge obstacle to your long-term financial well-being.
Back to the Future
Investing is future based but rooted in history. This history forms the evidence through which we can learn, if we are willing, how markets actually behaved in the past. While future investment returns likely won’t exactly mirror the past, the very long (almost 90 years) swath of historical observations is important.
One of the more interesting and useful components of market history is the contrast between actual returns and intra-year (during the year) declines. The chart below reflects actual returns for the S&P 500 (the bars) against the lowest point during the year (the negative numbers in red scattered along the bottom half of the chart). Despite average intra-year declines of over 14%, annual returns were positive in 26 of the 34 years. This strongly amplifies the value of sticking to an investment plan in the face of short-term declines.
The chart above only covers the past 34 years but of interest, the percentage of positive to negative years is almost the same for the extended market history timeframe dating to 1926.The lesson is that indeed there will be negative years but these years will be far fewer in number than the positive years. Of course, no one can predict when the negative periods will occur so you have to be in the market all the time to obtain the returns from the positive timeframes.