One of the main problems with investing deals with expectations. Sometimes investors don’t know what to expect while other times, investors have expectations that are way out of line.
For example, over the long term, an index of U.S. small stocks has historically had a 12% return (from 1923 to today – past performance is no indication of future returns).
But, how many times was the return around 12% – say between 10% and 14%? Most investors are surprised to learn that the answer is zero. There is not a single year (yet) when the return of small stocks fell within this range. Despite this, there were numerous years where returns were in the 40s%, 50s%, 60s% even 70s% followed by years with significant negatives losses.
If investors don’t know where asset classes within their portfolio or their portfolio in total are going to clock in then they don’t have appropriate expectations. This makes it very hard to remain disciplined – particularly for the short term.
So if you expect the US small part of your portfolio to have about a 12% return each year, you will be disappointed. But if you know its return over the long term is around 12% and that on a year to year basis it has never been 12% – you are more likely to remain disciplined.