7 Enticing Facts About Investing Returns Over the Past Two Decades

The last decade has felt like a particularly rough one for investors, so I was surprised to learn recently that the S&P 500 (SNPINDEX: ^GSPC  ) has had only one negative year over the past 10 years. That was just one of the many intriguing facts that I discovered by looking at The Callan Periodic Table of Investment Returns.

Callan's table plots the annual returns for key indexes in rank order over the past two decades. The nine key indexes are: S&P 500; S&P 500 Value; S&P 500 Growth; MSCI Emerging Markets; MSCI EAFE; Russell 2000 (RUSSELLINDICES: ^RUT), Russell 2000 Value; Russell 2000 Growth; and the Barclays Aggregate Bond Index.

Among the surprising facts I learned are:

  • The MSCI Emerging Markets Index has led all of the other key indexes in seven of the past 10 years.
  • The Barclays Aggregate Bond Index has been at the bottom of the table in seven of the past 10 years.
  • Small caps (Russell 2000 Index) have outperformed large caps (S&P 500) in seven of the past 10 years.

Just as my pattern recognition faculties began making sense of things, I also learned, however, that:

  • The MSCI Emerging Markets Index came in dead last among all of the key indexes in five of the 10 years from 1993 to 2002. It came in last overall for seven of the last 20 years.
  • Even though the Barclays Aggregate Bond Index came in last seven of the past 10 years, it crushed the S&P 500 by over 42 percentage points in 2008.
  • And while small caps tended to outperform large caps in most years over the past decade, large caps outperformed small caps for five consecutive years from 1994 through 1998.

So what should we make of this somewhat contradictory array of market data?

Perhaps nothing at all. In fact, all of this data might serve as a perfect example of our all-too-human desire to make patterns out of random data. Resisting the urge to make investments based on our pattern-creating tendencies might just save us a lot of money over the long run.

Your most dangerous investment advisor
In his classic book "Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich, the investing writer Jason Zweig warns of the dangers of searching for patterns in random data. He writes that, "When it comes to investing, our incorrigible search for patterns leads us to assume that order exists where often it doesn't."

In Zweig's book, Professor Michael Gazzaniga talks of the part of the brain known as the "interpreter," which is constantly searching "for explanations and patterns in random or complex data." Relying on the interpreter in investing is particularly dangerous because we may think we've identified a pattern that is more likely an illusion.

For example, we might look at the Callan Table and conclude that small caps will outperform large caps over the next 10 years because of their record of relative outperformance over the past 10. Or we may determine that it's not worth diversifying our portfolios with bonds, since they've consistently underperformed the other indexes in most years over the past decade.

Those are just two very simple examples for illustration purposes, of course. The real takeaway from looking at the Callan table is that we shouldn't leap to conclusions when interpreting market data. Indeed, Zweig notes that the problem with pattern recognition and the investor brain is that it's unconscious, automatic, and uncontrollable.

We may conclude, for example, that investing in the MSCI Emerging Markets over the next decade is a can't-miss-idea solely because the index has been on such a roll over the past decade. Such an approach would probably be very unwise, however. A much better reason to invest in emerging markets would be because your extensive research leads you to believe that those countries will perform well going forward due to their strong economic fundamentals.

For me, the Callan table really drives home the importance of both dollar-cost averaging and diversification within your portfolio. I don't think most investors are capable of timing the market. And I suspect the vast majority will never know which investing style or asset class will be in or out of favor at any given time. Relying on our "interpreters" to make those decisions will likely end very badly.

Don't get burned
Zweig notes that the Ancient Scythians would burn to death any soothsayer whose predictions failed to come true. Thankfully, we don't have to worry about such extreme consequences if we decide to predict the future based on a snapshot of historical market data. We could lose a lot of money, however, which alone should be enough to discourage us from pursuing such a dubious strategy.

 

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 07, 2013, at 11:19 AM, Darwood11 wrote:

    Short term, things don't always go very well. I think that's the number one thing to be gained from Callan's table.

    For example, while the 10 year figures look good, EEM, a popular ETF ($50.17 billion in assets) for the MSCI emerging markets, has just about risen to the levels it had 5 years ago. (I don't include the annual yield in this).

    I think Callan's table really drives home the need to invest with a long term perspective. That doesn't detract at all from your article. It is however, an important component.

    I do think that the keys to investment success include:

    1. Diversification.

    2. Regular funding of investments.

    3. Making investments for at least 10 years.

    I suggest that readers consider that if a purchase doesn't appear attractive for at least 5 years, then they should not buy it. Most pundits can't predict next week, let alone next year. Five or 10 years is extremely difficult to predict for any single investment.

    That's why I have a sand box for short term decisions. Those decisions are based entirely on short term goals, and are rewarded by the psychology of short term investors. That sandbox, however, is limited to at most 10 percent of my total investments.

    My financial goals are entirely based on long term goals.

    Here's a trick question. If I am playing 10% of my investments in a sandbox, then how much of my financial management time should be spent on managing that 10%?

    As for pattern recognition, the fundamental problem is we're not good at predicting the future. Duh!

    At various times, reality diverges from the patterns. Add the herd mentality of the market, and we could literally follow any specific investment advice over the cliff.

    "Zweig notes that the Ancient Scythians would burn to death any soothsayer whose predictions failed to come true. " What a wonderful way to deal with our politicians at all levels. We want more government accountability? Stop rewarding dysfunctional behavior!

  • Report this Comment On March 07, 2013, at 11:33 AM, TMFBane wrote:

    That's a great point about the importance of having a long-term time horizon. It's likely the only edge that many of us have as investors.

    Thank you for underlining it! I couldn't agree more.

    Best,

    John

  • Report this Comment On March 07, 2013, at 2:27 PM, DavidWTaylor wrote:

    We have plenty of signs that US economy is recovering, back from last December and published on :

    ** I Know First system ** site.

    Just published today: First-time jobless claims unexpectedly fell by 7,000 to 340,000 in the week ended March 2, the lowest since the period ended Jan. 19, according to data today from the Labor Department in Washington. The median forecast of 50 economists surveyed by Bloomberg called for an increase to 355,000. The four-week average dropped to a five-year low.

    Orders for machinery and other factory goods that signal business investment surged in January, indicating confidence in the economy.

    The Commerce Department said Wednesday orders for so-called core capital goods, which also include computers, rose 7.2% from December. It was the biggest gain in more than a year and higher than the initial estimate the government made last week of a 6.3%.

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