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Using History to Understand the Stock Market and my Investing Plan

Since I’m less than three years removed from college, this is the first bear market that has affected my finances. I previously wrote that the one lesson I learned from this bear market is that I am not risk averse. I did some digging to further convince myself of this fact and to hopefully provide everybody with the information to determine their risk aversion. Here are a few facts and thoughts that I have stumbled across recently about long term investing.

  • Humans are more prone to remember the immediate past and forget the long-term past. For this reason, we are more likely to continue on the same course as the immediate past and repeat the mistakes of our long-term past.
  • Between 1901-1921, the real average annual return of the US stock market was 0.2%.
  • Between 1929-1949 it was 0.4%.
  • Between 1966-1986 it was 1.9%.
  • The historically normal real average return is 6.75%.
  • Dividends and earnings growth are relatively consistent over decades.
  • Speculation in the stock market (P/E ratios) accounts for the wild fluctuations.
  • Speculative forces have always reverted to the mean.
  • John Bogle defines reversion to the mean as “the tendency for stock returns to return to their long-term norms over time — periods of exceptional returns tend to be followed by periods of below average performance, and vice versa”.
  • The 20-year period between 1978-1998 produced returns of 13.3%.

From all of this information it is clear to me that the stock market is capable of producing below average returns for 20 year periods. Prior to 2000, the stock market returns were well above average. A reversion to the mean should not have been unexpected.

Why can I continue to not be risk averse after discovering that the stock market can provide 10 years of subpar returns? I choose to stay positive and take it as an opportunity to invest at a discount. If the returns stay subpar for the next 10-15 years, I will be investing at a discount for that period of time, fully aware that a reversion to the mean in the positive direction is just around the corner. I am looking forward to the upward reversion to the mean to carry my net worth and myself into an early retirement.

Ben Graham warns: “Long-term investors must be careful not to learn too much from recent experience.” I implore everybody to learn at least one lesson from recent experience and many lessons from your long-term past experience.

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