Don't Let Averages Mislead You

Long-term averages can be comforting to investors, especially during when the markets are performing poorly. Over the past century or so, the stock market has averaged growth of about 10% per year. Unfortunately, that figure's not as reassuring as it seems.

Rein in your hopes
At best, averages can give you a fair sense of what to expect from an investment. You shouldn't expect 15% or 20% growth year in and year out in a broad-market index fund, for instance.

But knowing a stock or fund's average performance doesn't mean you can't do better -- or worse, especially over shorter periods. A peek at the S&P 500's returns over just the past five years will show you how much the index's performance can vary:

Data: Standard & Poor's.

It's supposed to be an aggregate
In addition, it's important to realize just how big an impact certain stocks can have on an overall average. For instance, Bloomberg recently reported that year-over-year sales growth for S&P 500 companies averaged 15.7%. But if you took out financials, which bounced back from their annus horribilis of 2008, the average fell to just 2.2% growth.

Financials didn't just pull up the average revenue for the S&P 500; many of them helped contribute to the index's overall returns in 2009, too. Goldman Sachs (NYSE:GS) saw its shares more than double, and Morgan Stanley (NYSE:MS) stock was up 88% in 2009.

Look for standouts
If you decide to invest in the whole index, you're making a trade-off. You get the simplicity that index investing provides -- but you've also tied your returns to that index. You'll own shares of both strong stocks and weak ones, and your return will reflect both.

On the other hand, you can try to do better than average by exchanging a broad index for individual standout stocks. Plenty of companies had a strong year in 2009, outpacing even the S&P's high returns. Bearing in mind that past performance doesn't predict future returns, just look at a few high-octane 2009 stocks that have earned considerable love from our Motley Fool CAPS community:

Data: Motley Fool CAPS.

It's smart to keep your finger on the pulse of our economy, and to realize that the recession has kept the market's big wealth-generators from performing as well as we'd like on average. Nevertheless, a little research can unearth both compelling standouts and companies you'd do well to avoid, in both good years and bad.

Don't be average
Averages may be reassuring, but they can also hold you back. By looking forward instead, and assessing a stock's future promise and potential, you'll do a better job at seeking out long-term winners.