Stock Returns Depend on How Long You Hold Your Stocks - Returns Are Cyclical

How much money will investors earn from stocks in the future? Returns obviously depend on the buy and sell price and the sell price varies according to how long you hold the stock. The following analysis of annualized returns using historical prices for the Dow Jones industrial average (^DJI quote and price chart) shows that returns tend to be cyclical. And the the magnitude of gains and losses decreases as the holding period increases.

To study the patterns of annualized returns, I (RAH) selected holding periods of 5, 10 and 20 years, which represent the investing horizon for many investors. For each holding period, I computed the annualized return for each purchase price during the period using monthly closing prices. The first purchase date for all holding periods is January 1929. The next purchase date is February 1929. The last purchase date for a holding period is the current month of the current year minus the holding period in years. For example, if the current date is October 2009, the last purchase date for a 10-year holding is October 1999.

For each purchase date, the sell date is the purchase date plus the holding period in years. The prices for the purchase date and sell date are used to compute the annualized return.

The results of the analysis are shown on separate charts, one chart for each holding period. The vertical axis represents the annualized returns and the horizontal axis represents the purchase dates. A profitable return is plotted with a green data point. An unprofitable return is plotted with a red data point.

5-Year Return Chart Shows Volatile Gains and Losses

For the three holding periods, the returns for the 5-year holding period are the most volatile. The largest gain is 31.64 percent resulting from the June 1932 purchase at the market low and the June 1937 sale. The largest loss is 24.57 percent for the purchase at the market peak in August 1929 and the subsequent sale in August 1934.

Around 80 percent of all purchases made money (green data points on chart).

The return chart shows three major cycles of annualized returns. The first cycle includes returns for 1929 and the first few years after the 1929 crash. The second cycle includes returns from the late 1930's to returns in the 1960's and 1970's. And the third cycle has two distinctive tops (3a and 3b on chart ) followed by a minor cycle beginning in the late 1990's.

The pattern of actual prices in the next few years will determine the pattern of returns for the 5-year buy-and-hold investors. The chart indicates returns could go lower, but short-term returns are volatile so a burst of upside prices could lift 5-year holding returns.

Click on the Annualized Return chart to enlarge it.

10-Year Return Chart Shows Two Major Cycles

Returns for the 10-year holding period occur in three distinct cycles (1, 2 and 3 on chart). The first cycle is associated with the 1929 crash and cycles 2 and 3 have upsides of 20 plus years and downsides with similar durations. In general, gains and losses are smaller than returns for the 5-year holding period.

Almost 90 percent of all purchases made money (green data points on chart).

Currently, the third cycle is on the downside. Returns for purchases made in 2000 and beyond are likely to remain negative until prices climb back above peak levels set in 2000 and 2007.

20-Year Return Chart Shows Downside of Current Cycle

Returns for the 20-year holding period occur in three distinct cycles. The first cycle is associated with the 1929 crash. The second cycle is complete and the third cycle is on the downside. In general, the gains and losses are smaller than returns for the 5-year and 10-year holding periods.

Over 95 percent of all purchases made money (green data points on chart).

No one knows for certain where stocks prices and subsequent returns are headed, but the chart pattern indicates that returns are headed down for the 20-year buy-and-hold investor, particularly for purchases made at relatively high prices around 2000 and 2007. If the current trend of decreasing annualized returns persists, buy-and-hold investors will see their returns go lower, making it difficult to make money from stocks.

Summary and Conclusions

Annualized returns occur in cyclical patterns for all holding periods. The patterns of returns shows primary cycles consisting of many secondary cycles of shorter duration.

Short-term investments are more volatile than longer term ones. As holding period increases, the magnitude of gains and losses becomes smaller.

And as holding period increases, more investments tend to make money. So to counter the effect of cyclical stock market returns, buy-and-hold stocks for a long time.

For more information about stock returns as related to holding periods see, Patient Buy-and-Hold Stock Market Investors Will Make Money and Stock Market Returns Become Less Volatile With Time.

See Stock Market Returns With Dividends Are Cyclical for charts of total returns with dividends for the S&P 500.

Related Articles:

CTM Percent Returns Indicate Tough Times Ahead for Investors
Price Bubbles Always End Badly
Stock Market Follows Multiyear Cycles to view major stock market cycles since 1871.
Stock Market Returns Are Likely to Decline for Buy-and-Hold Investors
Stock Market Returns Are Likely to Decline for Buy-and-Hold Investors - Part II

Updated Mar-20-10.