Investors tend to be either overly optimistic or overly pessimistic based on recent experience. They often think recent good or bad performance will continue indefinitely.
In simple terms, years of subpar stock returns will be followed by better returns to bring overall performance back to the long-term norm. It works vice versa, also.But investment returns over time are more likely to exhibit what economists call "mean reversion." That's the idea that over long periods the annual returns of various assets will swing back toward their long-term average—or back to the mean.
In the first nine months of this year, the S&P 500 stock index gained 19.8% including dividends, according to Morningstar Inc., after returning 16% in 2012. That is way above the average 11.2% from 1980 through 2012.
That suggests coming years could see returns that aren't as sweet.
One thing that isn't so likely is a period when returns match the long-term average, says Bill Stone, chief investment strategist for PNC Wealth Management in Philadelphia. "You see an awful lot of outliers," or numbers that are much better or worse than the average, he says. "You end up getting more numbers that aren't like the average than are like the average."
One way to iron out the ups and downs of the market is with an automatic investment plan, whereby a set amount of money is invested each month. That helps investors reduce the risk of making a big bet on the market at the wrong time.
See original story here.