What Are Historical Returns?
Historical returns are often associated with the past performance of a security or index, such as the S&P 500. Analysts review historical return data when trying to predict future returns or to estimate how a security might react to a particular situation, such as a drop in consumer spending. Historical returns can also be useful when estimating where future points of data may fall in terms of standard deviations.
- Historical returns are often associated with the past performance of a security or index, such as the S&P 500.
- Investors study historical return data when trying to forecast future returns or to estimate how a security might react in a situation.
- Calculating the historical return is done by subtracting the most recent price from the oldest price and divide the result by the oldest price.
Understanding Historical Returns
Analyzing historical data can provide insight into how a security or market has reacted to a variety of different variables, from regular economic cycles to sudden, exogenous world events. Investors looking to interpret historical returns should bear in mind that past results do not necessarily predict future returns. The older the historical return data, the less likely it'll be successful at forecasting returns in the future.
A historical return for a stock index such as the S&P 500 is typically measured from the open on January 1st to the market's close on December 31st to provide the annual return. Each year's annual return is compiled to show the historical return over several years. Investors can also calculate the average historical return, i.e., a stock has returned an average of 10% per year for the past five years. However, it's important to note that an average historical return doesn't mean that the stock price didn't correct lower in any of those years. The stock could have experienced price declines, but in the other years when the stock price rose, the gains more than offset the declines so that the average historical return was positive.
Investors can calculate the historical return for any investment, including the value of a home, real estate, mutual funds and exchange traded funds (ETFs), which are funds containing a basket of various securities. Investors also use historical returns to measure the price performance of commodities such as corn, wheat, gold, and silver.
How to Calculate Historical Returns
Calculating or measuring the historical return of an asset or investment is relatively straightforward.
Subtract the most recent price from the oldest price in the data set and divide the result by the oldest price. We can move the decimal two places to the right to convert the result into a percentage.
For example, let's say we want to calculate the return of the S&P 500 for 2019. We start with the following data:
- 2,506 = the S&P 500 closing price on December 31, 2018
- 3,230 = the S&P 500 closing price on December 31, 2019
- 3,230 - 2,506 = 724
- 724/2,506 = .288 or 29%*
*The returns were rounded to the nearest number.
The process can be repeated if an investor wanted to calculate the return for each month, year, or any period. The individual monthly or yearly returns can be compiled to create a historical return data set. From there, investors and analysts can analyze the numbers to determine if there are any trends or similarities between one period or another.
Historical Chart Patterns
In contrast to traditional fundamental analysis, which measures a company's financial performance, technical analysis is a methodology that forecasts the direction of prices through the study of charting patterns. Technical analysis uses past market data, such as price moves, volume, and momentum.
The historical returns are often analyzed for trends or patterns that may align with current financial and economic conditions. Technical analysts believe potential market outcomes may follow past patterns. Hence, there is a hidden value available from the study of historical return trends. However, technical analysis is more often applied to short-term price movements of those assets that frequently fluctuate in price, such as commodities.
Longer-term price trends tend to follow economic conditions and the long-term market outlook for the asset or investment. For example, the long-term historical return of a stock price over several years will likely have more to do with the market outlook for that industry and the company's financial performance than any technical charting pattern.
Analyzing Historical Returns
In reality, historical returns analysis often yields mixed results in determining trends. As a dynamic and ever-evolving system, markets and economies at times repeat, but it can be difficult to anticipate when past returns will occur again in the future.
Similar Events: Recessions
However, there are some merits to analyzing historical returns since we can gain insight as to what we might be in for in the near future. For example, the recession in 2020 might lead investors to compare the S&P 500 return in 2020 to the last time the U.S. experienced a recession; in 2008 and 2009.
In the context of recessions, exogenous events, economic conditions, and the resulting business and consumer spending patterns affect the stock market differently in each recession. As a result, when comparing historical returns, the drivers of those returns should be considered before concluding that a trend exists. If the underlying catalysts for the historical returns are completely different than the current situation, it's likely that the future returns will not mirror the historical returns analysis.
Perhaps the conclusions drawn from the study of historical returns don't provide investors with a crystal ball. Instead, the analysis provides context into the current situation. By knowing how an asset's price behaved under certain circumstances in the past can provide insight as to how it might react in the near future–with the understanding that the return won't be the same.
From there, investors can plan their asset allocation, meaning what types of holdings to invest in, and develop a risk management strategy in case the price of the market or asset moves adversely. In short, historical returns analysis might not predict future price movements, but it can help investors be more informed and better prepared for what the future holds.