There is a story of two actuaries who went duck hunting. As they were sitting in their blind, both actuaries took aim at the same duck. The first actuary fired and missed twenty feet to the left while the second actuary fired and missed twenty feet to the right. A fellow hunter, watching this display of sharpshooting, was confused to find the actuaries celebrating. When he asked the actuaries to explain themselves the actuaries said, “On average, they had scored a direct hit.”

The problem is that averages rarely reflect lived experiences. This actuarial approach to duck hunting is like investing where top-line averages can mask the real-life experience of an investor. The past three years have been an excellent case in point. The US stock market has historically returned 8-10% per year on average but if you set out on your investing journey expecting an 8-10% return per year, you’re going to be in for some surprises. For example, in 2021 the US stock market returned +26%, in 2022 it posted a -19%, and as of this writing on December 19th the US stock market is up +24%.

This means over the past three years the US stock market has averaged a 10.3% return, which fits our long-run average, despite none of these individual years being near our average. Now, percentages can give us information, but they are vague and unemotional so let’s add some money to our example.

The below chart shows the performance of a $500,000 401K over the past four years. At the end of 2021 this person’s 401K would have risen to $630,000. Then in 2022 the 401K drops down to $510,300. Finally, in December 2023 the 401K is worth $632,772. This gets you a +10.3% return over three years, but it’s quite the roller coaster.

In my mind, that is the real investment journey behind the averages. The journey is not only filled with numerical ups and downs but with emotional ups and downs as well. When your portfolio is rising there can be a great satisfaction from seeing your wealth increase. Conversely, it’s tough to watch your portfolio take a $120,000 haircut in a single year and there is temptation to make major financial decisions at inopportune moments.  

This brings us to how the market has performed in 2023. As stated earlier the US stock market has returned +24%. This on its own is not out of the ordinary. If we were to look back all the way to 1926, we’d see that once every four years the stock market posts a return between +13% and +24%.

What is unique to 2023 is the composition of that 24% return. At different points throughout the year, we’d be able to attribute 70% to 90% of the US stock market’s return to only seven companies. That means if the entire US stock market is up 24%, then 16.8% is thanks to the performance of Apple, Microsoft, Alphabet, Amazon, NVIDIA, Tesla, and Meta. That is a very unusual circumstance. In 2023 we have seen a normal year driven by very abnormal underlying performance.

This means as investors we face two challenges:

1. Most years do not look average.

2. Unique circumstances (The Magnificent Seven) can lead to normal outcomes.

So how do we as investors navigate these two challenges? I think it starts with having a long-term mindset and avoiding the temptation to make active management decisions.  

Charlie Munger, a famed investor who passed away this November, always did a great job of describing the benefits of having a long-term mindset, “It’s waiting that helps you as an investor, and a lot of people just can’t stand to wait. If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that.” If you don’t have the patience to invest over the long-term or can’t stomach the portfolio declines that I illustrated earlier, you won’t capture the 8-10% average return which has been one of the greatest generators of wealth over the past hundred years.

Finally, your investing strategy should be dictated by your goals, not macroeconomic forecasts, or the hottest stocks. Predictions are difficult and even professionals are wrong more often than they are right. Standard & Poor releases an Index vs. Active report twice a year and the results speak for themselves. When examining the results over 10 and 20-year time periods, active management has an average failure rate of 80-90%. This isn’t because these managers are not smart, but instead it goes back to how unpredictable and unique circumstances can compound to unexpected yet normal results. A great example of this is looking back at predictions from major Wall Street firms on where the S&P 500 would stand at the end of 2023. At the start of the year none of the major Wall Street firms were expecting the S&P 500 to approach its all-time high and no one expected seven companies to generate 70% of the US stock market’s return for the year.