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djia

With the recent volatility creating instability in people’s portfolios and peace of mind, I thought I would take a look at how the DJIA (Dow Jones Industrial Average) has performed over the past 30 plus years since 1975. In this time frame, the DJIA has ranged from a high return of 38% in 1975 to a (-17%) loss in 1977. From 1975 to 2006, there were 23 positive years and 9 negative years. If you were to take a simple average of the yearly returns over this time period, you would come up with an average return of 10.83%

Does this mean you will earn a 10.83% yearly return by investing in the DJIA? NO. Some years you will earn that or more while others you will earn less, even lose money. What your overall return will be is not as simple as taking an average. Let me give you an example: Two people invest their money in different financial instruments over 5 years. The first investor earns a flat rate of 8% each year, while the second investor earns 15%, (-3%), 18%, (-12%), and 22% over the five years. Both of these investors have earned a simple average of 8% for the 5 years, but do they have the same amount?

Investor 1:

Initial Investment $10,000.00

After Year One 8% Gain $10,800.00

After Year Two 8% Gain $11,664.00

After Year Three 8% Gain $12,597.12

After Year Four 8% Gain $13,604.89

After Year Five 8% Gain $14,693.28

Investor 2:

Initial Investment $10,000.00

After Year One 15% Gain $11,500.00

After Year Two (-3%) Loss $11,155.00

After Year Three 18% Gain $13,162.90

After Year Four (-12%) Loss $11,583.35

After Year Five 22% Gain $14,131.69

As you can see, investor one earned almost $562.00 more even though they calculated to the same simple yearly average. However, in actual returns, the first investor earned over 5.5% more over the five year investment. I bring this example up to show the value of minimizing the negative returns. The best way to do this is by diversifying, not only in different stocks, but in different asset classes. Finally, keep in mind, historical data does not mean that the future will be the same, but rather can be used as a starting point for predicting a reasonable return.

 

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