Understanding market history can be the antidote for financial failure. However, there is more. Comprehending the historical impact of inflation on wealth as well as your own financial history, rounds out the cure for failing financially. Conversely, ignoring (or misunderstanding) the markets, inflation, and your history can provide a huge obstacle to your long-term financial well-being.

Back to the Future

Investing is future based but rooted in history. This history forms the evidence through which we can learn, if we are willing, how markets actually behaved in the past. While future investment returns likely won’t exactly mirror the past, the very long (almost 90 years) swath of historical observations is important.

One of the more interesting and useful components of market history is the contrast between actual returns and intra-year (during the year) declines. The chart below reflects actual returns for the S&P 500 (the bars) against the lowest point during the year (the negative numbers in red scattered along the bottom half of the chart). Despite average intra-year declines of over 14%, annual returns were positive in 26 of the 34 years. This strongly amplifies the value of sticking to an investment plan in the face of short-term declines.

Source: Standard & Poor’s, FactSet, J.P. Morgan Asset Management.
Returns are based on price index only and do not include dividends. Intra-year drops refers to the largest market drops from a peak to a trough during the year. For illustrative purposes only. *Returns shown are calendar year returns from 1980 to 2013 excluding 2014 which is year-to-date.
Guide to the Markets – U.S.
Data are as of 6/30/14.

The chart above only covers the past 34 years but of interest, the percentage of positive to negative years is almost the same for the extended market history timeframe dating to 1926.The lesson is that indeed there will be negative years but these years will be far fewer in number than the positive years. Of course, no one can predict when the negative periods will occur so you have to be in the market all the time to obtain the returns from the positive timeframes.

Investing Based on Evidence

As Nobel Laureate Eugene Fama said in his speech to The Nobel Foundation last year, “In the applied domain, finance is far and away the most successful area of economics in terms of penetration of theory and evidence into real world applications.” We have, at our fingertips, the ability to take this evidence and use it for our good if we desire. To do so, however, we must let loose the idea that someone, somewhere has a system to keep us in the markets when times are good, and out when times are bad. Most of the Wall Street marketing machine depends on investors following that precise formula.

Trying to predict the future, acting on impulse and being swayed by the media all run counter to the idea of investing based on evidence. Investing in portfolios managed to maintain asset class consistency, (like Dimensional Funds), in accordance with your own goals applies the evidence of history at the personal investment level.

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