Market Probabilities: What the Past Suggests About the Future

Even after the dreadful losses of 2008 — and despite numerous past recessions and even a Great Depression — the remarkably resilient U.S. stock market has returned, on average, about 11% per year since the mid-1920s.

That's for a portfolio of one-half large company stocks and one-half small company stocks (based on data from Ibbotson Associates, an industry leader in compiling market statistics). This assumes all dividends were reinvested and ignores the sad fact that in real life Uncle Sam confiscates a hefty portion of your gains.

Of course, knowing the market's average return has been 11% annually doesn't tell you what the return will be this year. And such an average obscures some pretty wild rides along the way — such as 12-month periods where losses were as horrifying as 69% and gains were as breathtaking as 240% (those two extremes occurred back-to-back in 1932-1933).

In fact, only about 5% of the time over the past 80+ years have stocks actually returned 11% (give or take 1%) in a 12-month period.

But what the market's long-term average return makes clear is that time is on the side of the long-term investor. The longer you're willing to keep your money in the market, the greater the likelihood of success.

According to the Ibboston data, if you had randomly picked any 12-month period to own stocks (from 1926 to today), you would have had a 74% chance of making money. How much money? Study the historical evidence in this table.

Column one shows you would have had about a 40% probability of making 20% or more, a 20% chance of making 10%-20%, and a 14% chance of earning 1%-10%. (NOTE: The table is based on "rolling" periods. After looking at results from holding periods that began on Jan. 1, the calendar was "rolled" to the next month to see what happened for the holding period that began on Feb. 1 — and so on. This gives a better understanding of the extremes you might expect.)

Now, notice that for five-year holding periods, losses occurred only 11% of the time. In other words, if you held your stocks for at least five years, you increased the likelihood of making money to 89%.

Also note that as the holding period lengthens, the very large gains and losses gradually disappear as the market moves closer to its long-term historical average.

Most importantly, notice that by the time you reach holding periods of 8-to-10-years, the likelihood of loss falls to only 3%.

As if you hadn't guessed, we're in one of those unusual but occasional "3%-of-the-time" periods right now. Through the end of 2008, the market has an annualized loss (-0.6%) over the past 10 years. (One bright spot: while the market has lost over the past decade, Upgrading has averaged gains of 6.1% per year.) In other words, from a historical perspective, these are indeed the most unusual of times.

One implication of this historical data is that it is highly probable that the market will recover — as it has many other times over the past 80+ years — and offer significant rewards to the patient investor.

Key reminders: The volatility of shorter-term investing periods is why we recommend a five-year time frame as a minimum for investing in the stock market. A 10-year period (or longer) is required, in our view, to consider oneself a long-term investor.

Although no one can guarantee a positive return from stock investing over the next five years, or even over the next decade, once the current "improbable" period passes, the probabilities for success seem to be solidly on your side.

Austin Pryor is the founder and publisher of the Sound Mind Investing newsletter and website. His desire is to help people understand and apply Biblically-based principles for making spending and investing decisions, ultimately helping them have more so they can give more.

Joseph Slife is a contributing author and editor for SMI. He spent 15 years with Crown Financial Ministries, co-writing articles with Larry Burkett and serving as executive producer for broadcasting. In addition to his work with SMI, Joseph is an adjunct instructor in the Dept. of Communication at Emmanuel College in Georgia.

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