The Illusion of the "Average" Return

What the market does one year, it may not do the next.

How routine is a 10% return? If you’ve been investing for a few years or more, you may have read this comment somewhere: on average, stocks return about 10% per year. Is that statement really true? Or is this “average return” a myth?

As they say, your results may vary. In basic math, the average historical long-term return for the S&P 500 does come out to about 10% per year. But that is certainly not a rule of thumb. In its best-ever 10-year period, the index cranked out average annual compounded gains of approximately 20%. If you stretch the window out to 20 years, returns have varied from average annual gains of about 18% to 3.1%.¹

What’s the inflation-adjusted return? That’s a great question. There are lots of ways to calculate average returns – some more illuminating than others. A Forbes article recently presented the findings of a financial advisor who calculated the actual long-term average annual return of the S&P 500 from 1926 to 2008 with dividends reinvested but before taxes and transaction costs. According to his math, the inflation-adjusted return of the S&P 500 across this timeline was +6.2%.²

Of course, the last ten years have given investors less gratifying results. A New York Times columnist found that over a 10-year stretch ending in January 2009, an investor holding the stocks in the S&P 500 index and reinvesting dividends would have realized an inflation-adjusted annual return of -5.1% per year. The total return for the S&P 500 over this period was -2.6% without factoring for inflation.³

The last 10 years have challenged our investing assumptions. The question begging to be asked is … Is the potential for additional return worth additional risk?

No one has a crystal ball. A $10,000 lump sum invested in the S&P 500 index at the end of 1996 would have grown to $23,011 at the end of 2006, for an average annual compounded gain of about 8.7%.¹ But who got out of stocks at the end of 2006?

Some food for thought. One of the truths of the financial world is that past performance is no guarantee of future results. The severity of this bear market has made many people search for conservative alternatives to equities, and strategies with the potential for less volatility. If you are searching for that kind of strategy yourself, confer with a qualified financial advisor who can show you your options.

 

 

Citations.

¹boston.com/business/personalfinance/articles/2009/03/24/yes_stocks_perform_over_the_long_term___but_dont_expect_consistent_returns?mode=PF         [3/24/09]

² forbes.com/2009/02/23/girouard-stocks-bonds-financial-adviser-network_returns_print.html           [2/23/09]

³ nytimes.com/2009/02/07/business/07charts.html?_r=1               [2/7/09]