As the investable world seems to get crazier and scarier with each passing year, making sense of it all can be difficult. It’s at times like these that we think it is wise to consider truth from the world around us, and how it applies to seemingly chaotic situations. Take for example, a river, when viewed from above, it appears as though its path is random chaos.
Yet, in reality, a river will always choose to take the most efficient route downslope, and it’s anything but random. If the river flow encounters an obstacle of resistance. e.g. some densely rooted soil, it will change direction and flow around that obstacle. In doing so, it preserves energy and takes the most efficient route. This process is repeated every single time it encounters an obstacle1. However, the result is not a straight line, as rivers almost never flow in a straight line. Rather, their movement is marked by twisting and turning, and what appears to the untrained eye to be chaos.
If you don’t understand how a river works, this process is disconcerting, and it might even induce panic, but once you have taken the time to learn about how a river flows, and the why the process works, you view it with appreciation and awe. You trust that it will do the job correctly. So it is with investing. Much like the river, our portfolio returns will rarely be straight, nor will they equal their exact annual average too often, or ever. (See the Charts Below2,3) They will twist and turn, in seemingly chaotic and unsettling patterns. However, if we have done our homework, learned how to build a proper investment portfolio, and understood why investments go up and down over the short term, we can understand why our efficient portfolio moves like a river, instead of a ruler. This allows us to rest assured knowing that our portfolio is taking the most efficient path to our goal, even if it includes twists and turns along the way as it encounters inevitable obstacles.
Source: Dimensional Funds
“The chart shows the distribution of returns of the Standard & Poor’s 500 Index going back to 1926. During the course of the 89 years covered by the chart, we never had a single year when the annualized compound return was simply the average! This means that if you are expecting your returns to fall somewhere around 8 percent to 10 percent in a given year, you have — at least so far — been disappointed.”2
1Source: River Landforms, http://thebritishgeographer.weebly.com/river-landforms.html
2Source: Bloomberg View, “Average Returns, Rarer than you think” by Barry Ritholtz
3Source: Business Insider, “Average almost never happens in the markets” by Sam Ro