I think we can safely say that most investors don’t make decisions based on the long-term history of the stock market. They generally look at the most recent 1-, 3- and 5- and sometimes 10-year returns and assume that recent past performance will persist. Unfortunately, they don’t understand that short-term returns are based on random news and that investment decisions based on 50 years of data have a higher probability of enhancing wealth than decisions based on five years of data.

Historical stock market data provides investors with a powerful set of tools for constructing portfolios that can maximize expected returns at given levels of risk. By analyzing the historical returns for various asset classes, including stocks, bonds, private equity, real estate, and even precious metals, an investor can see the difference between compensated and uncompensated risk over time. Statisticians require data from periods of at least 30 years to minimize the sampling error of short-term data and to provide a more reliable estimate of expected returns and risk. Very few managers are able to provide 30 years of data to their clients.

Historical data serves as a testament to the enduring nature of capitalism. By considering and understanding long-term data, investors can use the long-term risks and returns for various indexes to construct an asset allocation based on history and the science of investing, not on speculation.

Step 9IntroductionHistoryshort-term returnslong-term returnssampling errorcapitalism