Why there’s no such thing as a typical year

12 July 2021

3 minute read

While better reporting may help investors form an expectation of the typical returns they can expect from an investment, here we explore why anchoring on typical returns can lead to regular dissatisfaction.

Who's it for? Confident investors

What you’ll learn:

  • What is an ‘average’ year?
  • Why are returns so dispersed?
  • Where to invest?

The world around us is constantly changing. But by how much do we adapt or alter our behavior to these events? Probably not a great deal. It becomes natural to just go with the flow and accept that life is never really constant.

Is investing any different? With innumerable events occurring across the world affecting economies and markets in different ways every day, should we really expect to earn the same consistent returns year on year? Is there such a thing as a typical year in investing? In a word, no – past performance isn’t a reliable guide to future performance and what’s more, when you study historical investment returns you see that they can vary significantly from year to year. And yet, many investors have expectations around the annual return they’ll get which is a mistake and can often result in dissatisfaction.

Targeting long run returns

As Barclays investment experts, we tend to be unresponsive to many of the events that dominate the news headlines, looking beyond short-term events which can be transitory and have little impact on a fund. Instead we focus on long run expected returns to make sure funds are sensibly invested.

Our work in behavioural finance has shown us that in investing it is those deviations from expectations which lead to happy or unhappy investors. Getting better returns than expected creates happiness while getting less than expected makes for unhappy investors. It will feel appealing but judging each year in this way misunderstands one of the essential effects of investment time horizon.

An average year is, by definition, made up of both good and bad previous years, and the reality is that almost no single year will provide you with average returns across each asset class. Examining annual US share and bond returns over the past 90 years shows a very broad dispersion of returns, with just a handful of years when returns are within a small distance of their long run averages. Incidentally, the “most average” year would be 2004.

Why are these returns so dispersed?

Over longer periods, this dispersion of returns reduces and reverts closer to that average return. Investing for the long run as well as looking at longer periods of return may now seem less daunting and more sensible, again reiterating that there is no typical average year. Time really is your friend, which is why it is suggested that you should invest for a minimum of five years.

While diversification reduces the volatility of a fund, there is a way to help you control your own perception of volatility and return. In the same way that increasing your investment horizon reduces the probability of making a loss, checking your investments less often reduces the perception of riskiness that seeing red numbers can bring about, and decreases the probability of you not seeing the average return you envisaged.

Investment conclusion

The variability of returns is an unavoidable feature of investing. Some years will see very strong returns, some the opposite, and some may feel rather average.

Don’t beat yourself up about it – remember, it’s returns over longer periods of time which are important. Staying the course will increase the likelihood that your returns will look like the ‘averages’, which have been positive and better than cash, yet it’s worth remembering that this can’t be guaranteed. Investments can fall as well as rise, although as we explain above, staying invested for the long term, helps reduce the chance of you losing money.

Investments can fall as well as rise, although as we explain above, staying invested for the long term, helps reduce the chance of you losing money.

If you‘re itching to change your fund during periods of significant returns, a strategy some follow is to sell a bit when an asset is performing well and shift into others doing less well – this is rebalancing your portfolio to manage risk but also reinforces good behaviours.

The key message here is to try not to get too fixated on those average return figures over shorter periods. Instead, focus on the longer term performance by checking your portfolio less frequently and turning the volume down on some of the day-to-day news stories you hear.

Where to invest

The Barclays Ready-made Investments are just one example of a range of diversified funds which allow you to select the level of risk you are most comfortable with. These multi-asset funds invest across a range of asset classes and regions, offering a globally diversified one-stop solution for investors. Ready-made Investments are not the only funds that we offer and they won’t be appropriate for everyone.

These funds are designed for the long term so you should only consider them if you can stay invested for at least five years.

All of these investments can fall in value as well rise; you may get back less than you invest.

These are our current opinions but the future, as ever, is uncertain and outcomes may differ.

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The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances. Smart Investor doesn’t offer personal financial advice. If you’re not sure about investing, seek independent advice.

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