The Basics of Investing - How predictable are market return?
The financial markets are inherently uncertain.
Markets react to random, unexpected events so, by their very nature, they are unpredictable — at least they are in the short term. Equity markets in particular can fluctuate wildly.
Of course that doesn’t stop market pundits making predictions about where markets are heading.
And the financial media loves market forecasts — not least because of its insatiable appetite for “stories”.
But such predictions don’t bear close scrutiny. Human beings — even so-called experts — are notoriously poor at predicting market movements.
That said, long-term market returns are much more reliable.
Nothing illustrates this better than the Periodic Table of Investment Returns, which was devised by Callan Associates in California.
The table shows the returns for ten different asset classes over a 20-year period.
The asset classes are colour-coded so you can track them over time.
Each column illustrates the returns for a particular year. The asset classes with the biggest returns are at the top and those with the lowest are at the bottom.
You’ll see from the mass of different colours that there are no discernible patters patterns. Asset classes fall in and out of favour very suddenly.
However, over the long term, asset class performance tends to revert to the mean.
So, over the whole 20-year period, the average return for each asset class is more or less what you’d expect it to be.
Yes, equity investors will inevitably have to contend with periods of extreme volatility. For long periods their portfolios will be worth considerably less than they once were. But, as long as they resist temptation to bail out when their fellow investors take fright, they can expect to be rewarded eventually with far higher returns than for bonds.
Similarly, over time, corporate bonds will generally return more than government bonds, which in turn will produce higher returns than cash.
In conclusion, then, it’s best to ignore short-term forecasts, have a highly diversified portfolio, sit tight and invest for the long term.
Nobody knows what the markets will do next week, next month or even next year. But those with at least a 20-year horizon can afford to invest with confidence.