Can You Use Historical Volatility For Something Other Than Finances DJIA – Historical Performance of the Dow Jones Industrial Average

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DJIA – Historical Performance of the Dow Jones Industrial Average

With the recent volatility that has created 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 years since 1975. In this time period, the DJIA has ranged from a high of 38 % in 1975 to a loss (-17%) in 1977. From 1975 to 2006, there were 23 positive and 9 negative years. If you were to take a simple average of the annual returns over this time period, you would get an average return of 10.83%

Does this mean you will get an annual return of 10.83% by investing in the DJIA? NO. Some years you will make that or more while others you will make 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 for 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. These two investors earned a simple average of 8% over the 5 years, but do they have the same amount?

Investor 1:

Initial investment $10,000.00

After the first year, you earn 8% of $10,800.00

After the second year, 8% earn $11,664.00

After the third year, 8% earn $12,597.12

After the fourth year, 8% earn $13,604.89

After the fifth year 8% earns $14,693.28

Investor 2:

Initial investment $10,000.00

After the first year, 15% profit of $11,500.00

After the second year (-3%) Loss of $11,155.00

After the third year, 18% earn $13,162.90

After the fourth year (-12%) loss of $11,583.35

After the fifth year 22% earn $14,131.69

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

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