Posted by Mike Smith :: April 1, 2009 @ 6:11 am

When the major stock indices started hitting 10-year lows in late February, many people started questioning the historical return number they used to make their investment plans. Even getting past the fact that historical returns are no guarantee of future performance, a key factor that is often forgotten is that quoted historical returns of the stock market are based on the long-term.

To an investor whose retirement portfolio has taken a major hit, even a year or two for a recovery may seem like a long time. Anyone who needs their investment proceeds soon probably should have been more conservative and had their portfolios more in fixed income than equities. It’s easy to think of these past ten years of flat performance as a lost decade, but the historical numbers we hold so dear include decades with flat or declining returns.

The trouble is that the historical return numbers used in many retirement calculators and investment plans span a much longer interval than even the decade level. “Long-term” is often thought of as more than five years, but significantly longer periods are much more appropriate. An entire adult lifetime is a more applicable measure of long-term. So investing for retirement during your whole career might allow you to achieve returns near those found historically.

When you invest for the long-term, there will be some ups and downs, with stretches of outstanding performance and others of painful declines. In order for annualized performance to revert to the historical average, it makes sense that periods above that average would have to be counter-balanced with times below. The declines of the past year are certainly disconcerting, but are part of the journey that all investors face. In desperate times, it helps to remind yourself that long-term performance is just that: it’s what we might expect over a very long period of time.

How do you define “long-term” for investments?