Underscoring the unreliable nature of 5- and 10-year return calculations, a recent market commentary from Vanguard notes the impact of just one year’s worth of data falling out of a rolling period. For example:
• The 10-year average annual return of the total U.S. stock market rose to 8% as of year-end 2012, up from 4% a year earlier. While it’s true that U.S. stocks were up 16% in 2012 versus 1% for 2011, that overlooks a more important factor: the negative 21% return from 2002 — the last year of the 2000-2002 bear market — fell out of the 10-year return calculations.
• This year, the negative 37% return from 2008 falls out of the 5-year return calendar, so that even if stocks go nowhere, their 5-year average annual return will jump from the current 2% to 12%, by Vanguard's calculations.
The lesson: evaluate returns over both bull and bear markets — although that’s easier said than done.
