the stock market explained

The Stock Market

A Wealth of Common Sense Explains

By Ben Carlson

www.awealthofcommonsense.com

Stocks Have Offered Solid Long-Term Returns...

From 1928 to 2012, the S&P 500 returned 9.3% per year.

And since 1900, the general trend in the markethas been up and tothe right

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…But Stocks Do Go Down By Large Amounts Periodically

Since 1928, there have been 20 periods with a decline of 20% or more in the S&P 500 as seen in this graph:

Source: Motley Foolwww.awealthofcommonsense.com

Stocks Rarely Perform Around the Average Long-Term Return in a Given Year…

• Since 1928, only 5.9% of the time has the S&P 500 finished the year with gains of between 7% to 12%.

• While 35.3% of the time it has gained more than 20%.

• And 22.4% of the time is has lost more than 5%.

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…But Longer-Term Returns Are Fairly Consistent

Average Calendar Year Rolling Returns for the S&P 500 from 1928 to 2012:

Average Rolling 5 Year Returns 9.8%

Average Rolling 10 Year Returns 10.4%

Average Rolling 20 Year Returns 11.1%

Average Rolling 30 Year Returns 10.8%www.awealthofcommonsense.com

Stocks Can Be Very Risky in Shorter Time Frames…

S&P 500 Loss January 1973 to October 1974 -48.2%

October 19, 1987 -20.5%

March 2000 to October 2002 -49.1%

October 2007 to March 2009 -56.7%

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…But Risk Generally Decreases Over The Long-Term

Standard Deviation of S&P 500 Returns From 1928 to 2012:

1 Year Calendar Returns 20.00% Rolling 5 Year Returns 8.61% Rolling 10 Year Returns 5.83% Rolling 20 Year Returns 3.41% Rolling 30 Year Returns 1.58%

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The Drivers of Stock Returns Are

1. Dividends2. Company Earnings Growth3. Emotions (Changes in Valuations)

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1. Dividends

From 1871 to 2011, the U.S. stock market returned 8.83% per year with reinvested dividends; without dividends reinvested it only returned 4.13%. (Source: Shareholder Yield by Mebane Faber)

Dividend yields have been fairly stable over the years

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2. Earnings

Earnings growth for the companies that make up the S&P 500 has also seen a long-term trend in the right direction:

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3. Emotions (Valuations)

But how much investors are willing to pay for earnings changes quite often:

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Because of These Emotions Stock Markets Can Go Nowhere For a Long Time…

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…Or Become Quite Bubbly

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Lessons?

• Have a long-term investment outlook• Know that there are risks over the short-term• The reason stocks have higher long-term returns is

because there is the possibility of short-term losses• Don’t invest in stocks unless you can ride out periodic

losses• Don’t invest in stocks if you need the money in a

short period of time• Don’t look at your portfolio balance on a daily basis

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For more information visit www.awealthofcommonsense.com

*Source for all S&P 500 return and graphical data used in this presentation comes from http://people.stern.nyu.edu/adamodar/New_Home_Page/datafile/histretSP.html &

http://www.econ.yale.edu/~shiller/data.htmAll other calculations are my own.

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