Long-term averages mask short-term turbulence
The S&P 500's long-run annualized return is roughly 10%, but that obscures the reality of investing. Individual years swing wildly: gains of 30-40% in boom years, losses of 30-50% in crash years, and modest single-digit moves in many others. An investor who sees '10% expected return' and expects steady, smooth progress will be shocked by the actual path.
The distribution of annual returns matters more than the average. Most years cluster between negative 20% and positive 30%, with occasional tail events exceeding those bounds. Understanding this volatility spectrum is critical for setting realistic expectations and avoiding panic during inevitable downturns.
Sequences of returns add another layer
Realized returns depend not just on volatility, but on the order in which returns occur. A retiree who experiences a 30% loss in year one faces a very different outcome than one who faces the same loss in year 30. Early losses require larger future gains to recover, while early gains get many years to compound. This sequence effect means the 10% average is meaningful only if you have decades to smooth out the volatility.