No Such Thing as Average

Within the financial talking points we often hear references made about the average rate of return for stocks, bonds, mutual funds, assets managers, inflation, etc, etc... These numbers are mostly used as a reference point and often times as part of someone's sales presentation. The time perspective can be long-term or can be specified in an explicit numbers of years or other time periods. The problem from a wealth management perspective and from a practical perspective: there is no such thing as an average rate of return.

While mathematically we can quote an average and be accurate in our statement of fact the real world effects, specific to our individual circumstances, can vary widely based upon other factors such as the sequence returns and the variability of returns. This is an important concept to understand when it comes to personal wealth management.

Coupled with the concept of "Investment Season" has provided us with insights into expectations for the various seasons. Those observations have educated us that it becomes very prudent to expect that there will be periods of above average returns and there will be periods of below average returns. Once you add all the observations up and divide by the total number of observations you will get the historical average.

The reason this can be analytically important is that the specific periods of below average or above average will often vary in duration. If wealth management decisions are based upon an average, and a below average period is experienced, than the expectations will, most likely, not be forthcoming. Even worse would be a scenario in which one "expects" above average returns and the actual experience presents below average returns. Under this scenario the expectations and the real world outcomes will be even further apart.

A simple yet effective example would be to consider the inflation numbers as they relate to our concept of investment seasons. For the period that began in 1926 and ended in 2005, the "average" inflation rate was 3.4 percent per year. However, when the Inflation Season of 19661982 is observed, the average inflation rate was 6.8 percent per year. Yet during this specific season there were individual inflation rates of 13.3% and 12.4% in 1979 and 1980. To further the point, compare this to the Stable Season experienced from 1950-1965. During those years the actual inflation rate came in at or below 2 percent per year. During the 1920's and 1930's this country faced periods of declining prices or deflation.

The point here is that the social, economic, political, and capital market consequences of these differing periods are extremely diverse. Yet, the statement can be made that the historical average inflation in the United States since 1926 has been 3.4 percent; and that is empirically correct and sounds unassuming.

For this reason, when considering investment alternatives, we do not rely just on 3-, 5-, and 10-year average returns. We also consider annual and monthly returns as well as other factors and influences that provide an indicator as to when above- or below-average returns may be expected.

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Any opinions are those of Charles H. Ballou, CFP® and Michael C. Ballou, CFP®, and not necessarily those of RJFS or Raymond James.

The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.