Monday, January 7, 2013

An example of why we don't annualize for periods less than a year

This weekend's WSJ reports that "U.S. stocks ended the first week of 2013 up 3.8%."

Some might want to annualize this figure, to get a sense of what the year will look like. To do so, we can simply raise 1.038 to the 52nd power, and subtract one.

And when we do this we get 595 percent!

What a great year 2013 will be.

Except, of course, that this is assuming that the remaining 51 weeks will perform as the first week has. Which, of course, is a tad unlikely. To annualize for periods less than a year violates the rule that past performance is no indication of future results, because we are taking it and applying it to the future.

We see folks annualize non-performance figures all the time. For example, a few years back, when the Yankee's Alex Rodriguez began the year hitting an extremely high number of home runs, someone annualized it to show that he would set a new single season record by quite a margin if he continued that pace. He didn't.

Sports folks aren't under the same rules that performance folks are; we know the rule: don't annualize for periods less than a year.

p.s., where's my clipart? The blog software is apparently having problems, so there won't be any until it's fixed. DARN!

2 comments:

  1. Stephen Campisi, CFAJanuary 9, 2013 at 5:04 PM

    And yet we typically annualize our inflation (CPI) measures each month when they are announced, expressing these current short term inflation changes on an annualized basis. It seems that we are comfortable talking about and visualizing some things only on an annualized basis.

    ReplyDelete
  2. Thanks! I'm sure there are other items, too, but NOT one's performance!

    ReplyDelete

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