After reading this, you will know more about investing than every caller that’s ever called into Jim Cramer’s show.
What we’ve learned so far….
Over the last 90 years, the average annual return for the S&P 500 is 9.8%.
Rolling returns less than 90 years vary. The longer you are invested, the smaller the variability becomes.
The 1-year rolling return varies between -47% to 61% per year.
The 20-year rolling return varies between 6.5% to 20% per year.
So the longer you are invested, the more predictable your return becomes. But long-term investing is not the only way to do this.
The other way is diversification.
“Don’t keep all your eggs in one basket.” Diversification is usually thought of a way to reduce risk. However, it’s also the way we get more predictable, consistent returns.
For example, consider two investments with identical return profiles.
Investment A: 9.8% average annual return / 20 year rolling returns between 6.5% and 20%
Investment B: 9.8% average annual return / 20 year rolling returns between 6.5% and 20%
The magic happens when you put them together. When you combine them, the new return profile looks like this:
Portfolio A & B: 9.8% average annual return / 20 year rolling returns between 8% and 17%
You retain the expected long-term return of 9.8%, but you reduce the variability of possible outcomes.
And now you understand Modern Portfolio Theory. Jim Cramer’s callers ain’t got nuthin’ on you!
