Friday, January 16, 2009

Was 2008 an Unprecedented Surprise?

Certainly, the stock market losses last year were severe and painful in asset classes all across the board, but they shouldn’t have been completely off of our risk/return radar. Historical market returns suggest that we anticipate an average return of about 10% with a one-year standard deviation (STD) of about 20.

If you remember your statistics course, one standard deviation (plus or minus) from the mean should cover about 2/3 of the expected values, two standard deviations (+/-) from the mean should cover 95% of your experience, and three standard deviations (+/-) are expected to include 99% of expected values. We would then expect 2/3 of future stock market returns to be between 30% and -10%; 95% of the returns to fall in the 50% and -30% range; and 99% of returns to be between 70% and -50%.

So while last year’s returns certainly were not common, neither were they a so-called ‘Black Swan’ outside of the realm of consideration from a historical basis.

Gluck, Andrew. “A Decade of Pain.” Financial Advisor, January 2009.

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