Ten Lessons the Market Taught Us in 2025

Every year the markets provide us with lessons on prudent investment strategies. With great frequency, markets offer remedial courses covering lessons they taught in previous years. That’s why one of my favorite sayings is that there’s nothing new in investing, only investment history you don’t know. In 2025, investors were provided with 10 lessons. Many of them are repeats from prior years. Unfortunately, too many investors fail to learn them—they keep making the same errors.

Lesson 1: Valuations Should Not Be Used to Time Markets

We entered 2025 with U.S. equity valuations at historically high levels. In particular, the popular metric known as the Shiller CAPE 10 was 37.14. The only two years we had begun with valuations above that level were 1999 (40.57) and 2000 (43.77). And 37.14 was more than double the historical average of about 17. That led some forecasters to predict poor returns. Investors who listened to that advice and sold equities missed out on the market’s strong performance as Vanguard’s S&P 500 ETF (VOO) returned 17.9%. That strong performance drove the CAPE 10 even higher to above 40 at year end.

In his 2012 study, Cliff Asness demonstrated why the CAPE 10 shouldn’t be used for market timing. He found that when it was above 25.1, the real return over the following 10 years averaged just 0.5% – virtually the same as the long-term real return on the risk-free benchmark, one-month Treasury bills, and 6.3 percentage points below the U.S. market’s long-term real return. This concerned many investors, leading some to reduce or eliminate their equity holdings. But there was still a wide dispersion of outcomes: The best 10-year forward real return was 6.3%, just half a percentage point below the historical average, while the worst was -6.1%.

While valuations do provide information on future returns, the research has found that they do not provide information that allows investors to profitably time the market. For example, Cliff Asness, Swati Chandra, Antti Ilmanen and Ronen Israel, authors of the study “Contrarian Factor Timing Is Deceptively Difficult,” which appeared in the 2017 Special Issue of The Journal of Portfolio Management, found “lackluster results” when investigating the impact of value timing (in other words, whether dynamic allocations can improve the performance of a diversified, multistyle portfolio). They wrote: “Strategic diversification turns out to be a tough benchmark to beat.”

In addition, what many investors may not be aware of is that when using traditional price-to-earnings (P/E) ratios, history shows there is virtually no correlation between the market’s P/E and how the market performs over the subsequent year. The following is a good reminder of that.

On January 1, 1997, the CAPE 10 was at 28.3. The highly regarded (at least at the time) Chairman of the Board of the Federal Reserve, Alan Greenspan, gave a talk in which he famously declared the U.S. stock market to be “irrationally exuberant.” That speech, given in Tokyo, caused the Japanese market to drop about 3%, and markets around the globe followed. Over the three years 1997 through 1999, the S&P 500 Index returned 33.4%, 28.6% and 21.0%, respectively, producing a compound return of 27.6%.

In summary, while valuations provide valuable information about future expected returns over the long term (there’s about a 0.4 correlation over 10-year periods), that doesn’t mean you can use that information to time markets. The evidence shows such efforts are likely to fail. This doesn’t mean, though, that the information has no value. You should use valuations to provide estimates of returns so you can determine how much equity risk you need to take in your portfolio to have a good chance of achieving your financial goals. But expected returns should only be treated as the mean of a potentially wide dispersion of outcomes. Your plan should address any of these outcomes, good or bad.

Lesson 2: Predicting the Future is Hard: The Inverted Yield Curve as Predictor

The inversion that lasted from summer 2022 through last summer was the longest ever. The inversion ended over a year ago and we are still awaiting that recession.

Since the 1960s, an inverted yield curve—when long-term rates (typically the 10-year Treasury) fall below short-term rates (typically one-month bills or 2-year notes)—has reliably signaled recessions, though the 2019 inversion proved prescient only technically, as bond traders couldn’t have predicted the pandemic.

The inversion that lasted from summer 2022 through last summer was the longest ever. The inversion ended over a year ago and we are still awaiting that recession.

Another previously reliable recession indicator, the ISM’s index of U.S. manufacturing activity, was in contraction for a whopping 26 consecutive months going into 2025. That streak ended in January when the index broke 50 and remained slightly above that in February. However, it ended the year on a new losing streak. The barometer tends to point down just as a recession is beginning.

ISM Manufacturing Index

Source: Trading economics

Investors who sold stocks based on the recession forecast missed out on the strong performance of equities over the period.

Lesson 3: Even With a Clear Crystal Ball, Markets are Unpredictable

Imagine that on January 1, 2025, you were provided with a crystal ball that would enable you to see the major geopolitical and economic events of the coming year:

• The war in Ukraine would drag on with no clear resolution.

• In the Middle East, Israel’s conflict would expand with cross‑border exchanges in Lebanon and Syria, even as Iran’s internal political unrest grew. The Bab el‑Mandeb strait would remain a choke point, with recurring Houthi attacks on shipping elevating global freight and energy costs.

• In a stunning escalation, the U.S. and Israel would jointly carry out coordinated airstrikes on Iranian nuclear facilities after intelligence indicated enrichment activity nearing weapons‑grade levels.

• The Federal Reserve would finally feel confident enough to begin a sustained easing cycle—cutting rates four times for a total of one full percentage point—but long‑term yields would prove sticky as the U.S. Treasury faced heavy issuance to finance another year of massive deficits.

• Inflation would moderate but remain above the Fed’s 2% target, with housing and services still stubbornly high. Wage growth would slow, real income gains would flatten, and consumer delinquencies would increase further, particularly in credit cards and autos.

• The U.S. ISM Manufacturing Index—a leading indicator of economic activity—would contract every month from March through December, its longest stretch below the 50 threshold since the early 2000s, signaling persistent weakness in industrial demand.

• U.S. consumer confidence would steadily erode throughout the year, weighed down by high borrowing costs, softening labor conditions, and stubborn inflation in essential goods and services.

• The “rolling recession” narrative would persist, hitting manufacturing, small business lending, and commercial real estate hardest. Office vacancy rates in major cities—San Francisco, Chicago, and even Manhattan—would hit new records as refinancing waves met higher-for-longer rates.

• The U.S. fiscal deficit would remain above 6% of GDP, the national debt would eclipse $37 trillion, and foreign demand for Treasuries would continue to wane as geopolitical blocs deepened and nations sought to diversify reserve assets.

• AI‑driven productivity and technology investment would surge, offsetting weakness elsewhere and helping large‑cap equities maintain elevated valuations.

Given this litany of challenges, few investors would have predicted another strong year for U.S. equities. Yet the S&P 500 returned 17.9%, powered by a narrow group of mega‑cap technology and AI‑linked firms. The lesson is that even if you could accurately predict events, you should not try to time markets.

Lesson 4: The Magnificent Seven Became the Magnificent Two in 2025

While the S&P 500 returned 17.9% in 2025, only two members of the Magnificent Seven—Nvidia and Alphabet—exceeded that benchmark.

While the S&P 500’s return for 2025 was 17.9%, the performance of the Magnificent Seven was responsible for most of the returns, as their average total return of 21.9% accounted for approximately 40% of the S&P 500’s overall performance. That performance was greatly impacted by investor fascination with the AI “story.” But history provides cautionary warnings about sky-high valuations driven by stories. As the table below demonstrates, the valuations of the Magnificent 7, with an average P/E of 64, are still reminiscent of the high valuations of the Nifty 50 and the dotcom stocks just prior to crashing. While not a forecast of a crash, it is a warning that at the very least these stocks, which currently make up about one-third of the total US market cap, are at historically extreme valuations. Fortunately, the rest of the market has valuations that are much closer to their historical averages.

The lesson is that it is very difficult for highly valued companies to continue to outperform over the long term. The reason is that the empirical evidence demonstrates that abnormally high growth in earnings tends to revert to the mean at a rate of about 40%, and real-world forecasts tend to underestimate the speed at which reversion to the mean in profitability occurs. For those interested in learning more about the lack of persistence of abnormal growth rates, I recommend a research paper by Verdad. Another lesson is that while “story” stocks may be fascinating, they typically don’t make for great investments.

Lesson 5: It Takes Patience and Discipline to Stay the Course Through Long Periods of Poor Performance—All Risk Assets Experience Them

Every investment strategy involving risk assets will experience extended periods of underperformance—this is virtually guaranteed. If you doubt that, consider that the S&P 500 Index has experienced three periods of at least 13 years when it underperformed riskless one-month Treasury bills (1929-43, 1966-82 and 2000-12). To gain the benefits of diversifying away from traditional 60/40 portfolios, you must have the discipline to stay the course (and even rebalance) during periods of negative performance.

Sadly, it’s my experience that when it comes to judging investment performance, investors think three years is a long time, five years is a very long time, and 10 years is an eternity. Financial economists know that when it comes to risk assets, 10 years is likely nothing more than noise – or the risks show up for which you are compensated with an expected, but not guaranteed, premium. If the premium were guaranteed, there would be no risk (and no premium). Investors who lack this understanding tend to abandon even well-thought-out strategies after a few years of underperformance. They fail to understand that underperformance typically results in much more favorable valuations and thus higher future expected returns.

The research on investor behavior has found that retail investors tend to underperform the very funds they invest in because they buy after periods of strong performance (when valuations tend to be high and expected returns low) and sell after periods of poor performance (when valuations tend to be low and expected returns high). In their 2023 study, “Mind the Gap,” Morningstar found that over the 10-year period ending in 2022, the average investor underperformed the funds they invested in by 1.7 percentage points per annum, losing about 20% of the available returns. The behavioral challenges to maintaining exposure to those premia are one reason they are likely to persist.

Two examples of the need for discipline are alternative investments–AQR’s Style Premia Alternative QSPRX and Stone Ridge’s Reinsurance Risk Prem Interval Fund SRRIX.

After returning 6.7% per annum from 2014 through 2017, a 6.4% premium over riskless one-month Treasury bills, QSPRX returned -12.3% in 2018, -8.1% in 2019 and -21.9% in 2020. That caused many investors to flee. In 2021, 2022, 2023, 2024, and 2025 the fund returned 25.0%, 30.8%, 12.8%, 21.12%, and 14.9%, respectively. Sadly, many investors were not there to earn those great returns because they lost discipline.

Investors in SRRIX had a similar experience. After returning 11.0%, 7.9% and 6.4% in 2014, 2015 and 2016, respectively, producing an annualized return of about 8.4% (an 8.3% premium over one-month Treasury bills), SRRIX returned -11.4% in 2017, -6.1% in 2018 and -4.7% in 2019. That caused many investors to flee. The next two years the fund returned 6.8% and -6.5%, and investors continued to flee. In 2022 the fund returned 5.1%. Then in 2023 It returned 44.6%, in 2024 it returned 33.1%, and in 2025 it returned 29.6%. Sadly, by the end of 2022, the fund’s assets had shrunk from a peak of about $5 billion to about $1 billion. Thus, most investors missed out on 2023’s, 2024’s, and 2025’s spectacular returns. In an annual investor letter, CEO Ross Stevens noted that performance chasing, engaging in resulting, recency bias, and the lack of patience and discipline led to the average investor in SRRIX underperforming the fund itself by almost 5% per annum.

The only way investors can benefit from diversification is to include unique risks (such as value stocks, international stocks and alternative investments) and to recognize that every risk asset will likely experience significantly long periods of underperformance. To get the benefits of what has been called the “only free lunch in investing” (diversification), you must have the discipline to stay the course, rebalancing a portfolio instead of allowing yourself to be subject to recency bias. In other words, diversification doesn’t eliminate the risk of losses. In addition, successful diversification requires accepting the fact that parts of your portfolio will behave entirely differently than the portfolio itself and may underperform a broad market index (such as the S&P 500) for a very long time. A wise person once said that if some part of your portfolio isn’t performing poorly, you are not properly diversified. Diversification isn’t easy. And losing unconventionally is harder because misery loves company. Investors should also be aware that that living through hard times is much harder than observing them in backtests, which helps explain why it’s difficult to be a successful investor – it’s our behavioral biases and the mistakes we make because we don’t know the historical evidence. The lesson is to not make the mistake of engaging in Resulting: Judging the quality of a decision by the outcome instead of by the quality of the decision-making process.

Nassim Nicholas Taleb, author of Fooled by Randomness, provided this insight into the right way to think about outcomes: “One cannot judge a performance in any given field by the results, but by the costs of the alternative (i.e., if history played out in a different way). Such substitute courses of events are called alternative histories. Clearly the quality of a decision cannot be solely judged based on its outcome, but such a point seems to be voiced only by people who fail (those who succeed attribute their success to the quality of their decision).”

In my book, Investment Mistakes Even Smart Investors Make and How to Avoid Them, the mistake of engaging in resulting is called “confusing before-the-fact strategy with after-the-fact outcome.” The mistake is often caused by “hindsight bias,” the tendency after an outcome is known to see it as virtually inevitable.

As John Stepek, author of The Sceptical Investor, advised: “To avoid such mistakes, you must accept that you can neither know the future, nor control it. Thus, the key to investing well is to make good decisions in the face of uncertainty, based on a strong understanding of your goals and a strong understanding of the tools available to help you achieve those goals. A single good decision can lead to a bad outcome. And a single bad decision may lead to a good outcome. But the making of many good decisions, over time, should compound into a better outcome than making a series of bad decisions. Making good decisions is mostly about putting distance between your gut and your investment choices.”

Former Treasury Secretary Robert Rubin explained it this way in his 2001 Harvard commencement address: “Individual decisions can be badly thought through, and yet be successful, or exceedingly well thought through, but be unsuccessful, because the recognized possibility of failure in fact occurs. But over time, more thoughtful decision-making will lead to better results, and more thoughtful decision-making can be encouraged by evaluating decisions on how well they were made rather than on outcome.”

Lesson 6: Risk Assets with Poor Performance Have Self-Healing Mechanisms

When risk assets have poor returns, it is usually due to a combination of both poor performance (falling earnings or producing losses) and falling valuations. Because the best predictor we have of real future equity returns is the earnings yield (the inverse of the P/E ratio, or E/P), falling valuations means that future expected REAL returns are now higher. Investors subject to recency bias fail to understand that, leading them to sell instead of buying.

For example, after underperforming one-month Treasury bills from 1929-43, the CAPE 10 had fallen from 25.3 to just 10.7. From 1944 through 1965, the S&P returned 15.0%, outperforming one-month Treasury bills by 13.2 percentage points per annum.

Similarly, after underperforming one-month Treasury bills from 1966 through 1983, the CAPE 10 had fallen from 19.7 to just 9.8. From 1984 through 1999, the S&P 500 returned 18.1%, outperforming one-month Treasury bills by 12.3 percentage points per annum. And after underperforming one-month Treasury bills from 2000 through 2012, the CAPE 10 had fallen from 44.2 to 21.2. From 2013 through 2021, the S&P 500 returned 12.6% per annum, outperforming one-month Treasury bills by 11.0 percentage points per annum.

Falling valuations are a “self-healing” mechanism. Similarly, the S&P’s loss of 18.1% in 2022 resulted in the CAPE 10 falling from 38.3 to 28.3.

Similarly, when value stocks underperform growth stocks, the spread in valuations between the two widens. Since the spread in valuations informs future relative returns, a wider spread forecasts a higher value premium.

The same self-healing mechanism works with reinsurance and credit markets. When losses occurred due to the historic fires in California, not only did premiums rise dramatically but underwriting standards tightened (such that you could not buy insurance if you had trees within 30 feet of your home, and all brush had to be cleared for another 30 feet) and deductibles increased significantly (reducing the risk of losses). Destruction from hurricanes in Florida caused the same combination of events to occur (rising premiums and deductibles, and tougher underwriting standards). Those events are what led to the spectacular returns to reinsurance investments in 2023, 2024, and 2025.

The same self-healing mechanism works in lending markets as well. Not only are credit spreads wider after losses, but underwriting standards are tighter, with covenants strengthened.

The lesson for investors is to remember that self-healing mechanisms are at work after periods of poor performance. Thus, sophisticated investors know that the winning strategy is to avoid being subject to recency bias and to follow Warren Buffett’s advice to avoid market timing, but if you cannot resist, “be fearful when others are greedy and be greedy only when others are fearful.” In addition, as we have discussed, don’t make the mistake of engaging in resulting.

Lesson 7: “Sell in May and Go Away” Refuses to Die—Despite the Evidence

Some investment myths persist despite overwhelming evidence against them. “Sell in May and go away” is a perfect example—a strategy that sounds clever but crumbles under scrutiny.

The Grain of Truth

There’s a reason this adage endures: historical data does show seasonal patterns. Since 1926, stocks have delivered stronger returns from November through April than from May through October. The numbers are striking: the S&P 500’s annualized premium over one-month Treasury bills was 10.65% from November through April compared to just 3.78% during the summer months—a difference of nearly 3-to-1.

The May-to-October period also experienced negative returns more frequently, with 33% of six-month periods in the red versus 27% for November-to-April periods.

So why not follow this pattern?

The Critical Detail Everyone Ignores

Here’s what the “sell in May” crowd conveniently overlooks: the May-through-October portfolio still delivered a positive annualized equity risk premium of 3.32% over Treasury bills. In other words, staying invested still outperformed cash on average.

Consider 2025 as a recent case study. Vanguard’s S&P 500 ETF (VOO) returned 27.3% from May through October, crushing the 2.1% return from one-month Treasury bills by 25.2 percentage points. In fact, with the sole exception of the bear market year of 2022, you’d have to go all the way back to 2011 to find the last time “sell in May” actually beat a consistently invested portfolio.

Why This Strategy Defies Logic

The “sell in May” strategy violates a fundamental principle of investing: the positive relationship between risk and expected return. To believe stocks should underperform Treasury bills from May to October, you’d also have to believe stocks become less risky during those months—an argument that makes no economic sense. Stocks don’t suddenly shed their volatility when the calendar flips to May. Market risk doesn’t take a summer vacation.

The Bottom Line

Despite its poor track record, this myth survives because it’s memorable and gets recycled by the financial media every spring. But memorable doesn’t mean profitable. The evidence is clear: staying invested beats trying to time the market based on calendar patterns.

You can be certain we’ll hear about “sell in May” again next spring. When you do, remember the numbers—and stay invested.

Lesson 8: Last Year’s Winners are Just as Likely to be This Year’s Dogs

One of the most persistent mistakes investors make is chasing last year’s winners. The allure is understandable—why not invest in what just succeeded? Yet the data tells a different story.

The historical evidence demonstrates that individual investors are performance chasers – they buy yesterday’s winners (after the great performance) and sell yesterday’s losers (after the loss has already been incurred). This causes investors to buy high and sell low – not a recipe for investment success. As I wrote in my book, The Quest for Alpha, that behavior explains the findings from studies that show investors tend to underperform the very mutual funds they invest in. For example, a 2005 study published by Morningstar found that in all 17 fund categories they examined, the returns earned by investors were below the returns of the funds themselves. Unfortunately, a good (poor) return in one year doesn’t predict a good (poor) return in the next. In fact, great returns lower future expected returns, and below-average returns raise future expected returns.

The table below compares the returns of various asset classes in 2024 and 2025. Sometimes the winners and losers repeated, but other times they changed places. For example, the best performer in 2024, the S&P 500 came in 6^th place in 2025, trailing the leading performer, the MSCI EAFE Value Index (the 7^th best performer in 2024) return of 42.3% by 24.4 percentage points. And the worst performer in 2024, the MSCI EAFE Small Cap Index returned 31.8% in 2025, the fourth best performance and almost 14% higher than that of the S&P 500 Index.

The lesson is that successful investing requires the discipline and patience to keep you from abandoning your long-term plan and avoid being subject to recency bias which results in performance chasing.

Lesson 9: Active Management Fails Even in Perfect Market Conditions

Return dispersion is a critical factor in active manager performance. Return dispersion is the range of returns for investments in an asset class.

—The Active Management Council, Investment Adviser Association

Despite decades of research showing that passive investing consistently outperforms active management, many individual investors continue to pay premium fees for actively managed funds. The evidence is clear: active management consistently underperforms passive strategies, whether markets are soaring or crashing. For example, S&P’s Persistence Scorecard has concluded: “Regardless of asset class or style focus, active management outperformance is typically relatively short-lived, with few funds consistently outranking their peers.” Despite this evidence, many investors continue choosing active funds, prioritizing the possibility of outperformance over the probability of success.

Last year presented active managers with ideal conditions to demonstrate their value. The S&P 500 returned 17.9%, but individual stock performance varied wildly—creating exactly the kind of environment where skilled stock pickers should theoretically shine.

For example, while the S&P 500 2025 total return was 17.9%, the stocks of the 10 best performing companies were up at least 108%. This 90+ percentage point spread created ample opportunity for skilled stock selection—simply overweight these stocks.

On the other hand, 10 stocks lost at least 40%, with the worst performer losing 68%. These stocks underperformed the index by 58 to 86 percentage points. This wide dispersion of returns is not at all unusual. Yet despite these obvious opportunities, active managers as a group once again failed to outperform low-cost index funds—as they do persistently, year after year.

Because indexes don’t incur expenses, while funds do, we need to compare the performance of active funds to those of actual index and systematic funds.

The Long-Term Verdict: Active Fails

The following table provides the percentile performance rankings of index funds from Vanguard and systematic funds from Dimensional for 2025 and the 15-year period ending in 2025. The results are striking.

The data shows that the longer the horizon, the better Vanguard’s and Dimensional’s funds ranked. At the 15-year horizon their funds ranked in the 25th and 24th percentiles, meaning these low-cost funds beat 75-76% of actively managed competitors. Even more significant: these rankings suffer from survivorship bias—about 7% of actively managed funds disappear every year and their poor returns vanish with them. Thus, over the long term the performance of active managers was actually far worse than the above rankings show.

Investor Takeaway

Year after year, active managers promise that “next year will be different.” They consistently predict that the coming year will be a “stock picker’s market”—a prediction that virtually never has come true.

Active management is ‘fraught with opportunity’—a deliberately ironic phrase. The opportunities are there, but the costs, behavioral biases, and difficulty of consistently identifying winners and avoiding losers make active management a poor choice.

The Bottom Line

Whether markets are bullish or bearish, calm or volatile, or return dispersion is narrow or wide, the evidence remains overwhelming: “passive” investing through low-cost index funds or systematic strategies gives investors the best chance of achieving their financial goals. The data from 2025—a year practically designed for active managers to succeed—only reinforces this truth.

Stop paying for hope. Start investing with evidence.

Lesson 10: Diversification Is Always Working—Sometimes You Like the Results, Sometimes You Don’t

Everyone is familiar with the benefits of diversification. It’s been called the only free lunch in investing because, done properly, it reduces risk without reducing expected returns. But once you diversify beyond a popular index such as the S&P 500, you must accept the fact that you will almost certainly be faced with periods (even long ones) when a popular benchmark index, reported by the media daily, outperforms your more diversified portfolio. The noise of the media will then test your ability to adhere to your strategy.

Of course, no one complains when their diversified portfolio experiences positive tracking variance (i.e., it outperforms the popular benchmark). 2025 was such a year when both developed international markets and emerging market equities far outperformed US equities. The only time you hear complaints is when it experiences negative tracking variance (i.e., it underperforms the benchmark like in 2023 and 2024).

The lesson for investors is that successful investing requires the discipline and patience to keep you from abandoning your long-term plan when diversification results in negative tracking variance to a broad market index.

Summary

It’s important to note that even smart people make mistakes. What differentiates them from fools is that they don’t repeat them, expecting different outcomes. 2026 will surely offer investors more lessons, many of which will be remedial courses. The market will provide opportunities to make investment mistakes. You can avoid making errors by knowing your financial history and having a well-thought-out plan. Reading my book “Investment Mistakes Even Smart People Make and How to Avoid Them” will help prepare you with the wisdom you need. And consider including in your New Year’s resolutions that you will learn from the lessons the market teaches.

My greatest hope is that you have learned that the key to successful investing is to get the plan right in the first place and then stick to it. That means imitating the lowly postage stamp, which does one thing but does it well—sticking to its letter until it reaches its destination. Your job is to stick to your well-developed plan until you reach your financial goals. And if you don’t have a plan, write one immediately. And make sure the plan includes the actions you are prepared to take if the “unexpected” happens (your “Plan B”).

Larry Swedroe is the author or co-author of 18 books on investing, including his latest, Enrich Your Future: The Keys to Successful Investing