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Don't be fooled by a trick of the calendar

February 24, 2014

When you're making investment decisions, it's easy to place too much importance on past performance. Anything that happened on Wall Street yesterday—or last year, or a decade ago—needs to be taken with a grain of salt, because returns from any particular period are an unreliable tool for gauging the future.

For example, the 2008 global financial crisis may seem like it just happened yesterday (and, granted, we're still living with the repercussions today), but it's more than half a decade in the past. As a result, the five-year average annual return for the broad U.S. stock market, as measured by the Russell 3000 Index, just made a startling bounce: from 2.04% for the period ended December 31, 2012, to 18.71% for the period ended December 31, 2013.

In other words, at the stroke of midnight this past New Year's Eve, five-year average annual performance for U.S. stocks jumped almost 17%. So, if you're only looking at what happened on Wall Street over the previous five years, the fact that those grim numbers from 2008—when U.S. equities plunged more than 37%—have dropped out of the equation makes things look much better than they would with a slightly longer-term perspective.

Average annual returns for U.S. stocks
over preceding five-year periods ended December 31
2007 13.63%
2008 –1.95
2009   0.76
2010   2.74
2011 –0.01
2012   2.04
2013 18.71

Note: The U.S. stock market is represented by the Russell 3000 Index. Data source: Vanguard.

The important thing to remember is that historical returns are just that: historical. Basing investment decisions on date-dependent snapshots could easily lead to an altered course—possibly in the wrong direction.

Instead, Vanguard believes, asset allocation strategies should be built on long-term risk-and-return relationships, always recognizing that no level of return is guaranteed.

Notes:

  • All investments involve some risk, including the possible loss of the money you invest.
  • Past performance is no guarantee of future results.
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