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Friday, April 8, 2011
The Annualized Total Return Roller Coaster
Here's an interesting set of charts that will especially resonate with those of us who follow economic and market cycles.
Imagine that ten years ago you invested $10,000 in the S&P 500. How much would it be worth today, adjusted for inflation with dividends reinvested? The purchasing power of your investment has grown to $10,533.11, an annualized real return of a rather disappointing 0.51%.
Had I posed the same question in March 2009, the answer would have been a depressing $5,518.55. The -5.93% real return would have cut the purchasing power of your initial investment virtually in half.
Now let's imagine that we time-travel back to September 2000 and pose the same question. Your ten-year inflation-adjusted gain would have been 396% for an annualized real return of 16.13%. As the chart illustrates, investment performance with a 10-year timeline has been a real roller coaster as far back as we have data.
If we extend our investment horizon to 20 years, the roller coaster is less volatile with higher lows and lower highs.
As these charts illustrate, and as many households have discovered over the past few years, investing in equities carries risk. Households approaching retirement should understand this risk and make rational decisions about diversification. They should also consider fixed income alternatives for that part of the nest egg that will pay non-discretionary expenses not covered by Social Security and pensions.