Stock Market Average Return- Are the Institutional numbers real or made up?
Its common to hear that the average market return is 10% not adjusted for inflation, but what does that truly mean? If you invest $100 in the S&P 500 January 1st 2018, does that mean that you have $110 in your account today? Not this year! And not necessarily. In fact as it stands now if you invested $100 in the S&P 500 in January 2018, your investment would be at $98.09 as of November. Meaning a near 2% loss. This right here is the first example of how stock market average returns can shy away from the actual return.
In the past 90 years, the approximate return is 10%, and as many know throughout those 90 years there have been ups and downs. However, one would expect to double their money every 10 years if the average return is 10%, 50% gain every 5 years and 200% every 20 years. This works in some situations but it is not consistent.
Stock Market Average Return-The S&P 500 and the DOW
When looking at stock market average returns, one must look at a benchmark. A benchmark that best encompasses the American economy. The stock market is a leading indicator of the American economy, and in recent years that privilege has been placed on the S&P 500.
The S&P consists of 500 large cap stocks, depending on their market cap, liquidity and industry. The S&P is now the benchmark for the US stock market and a fair reflection of the US economy. Its difficult to invest in the S&P 500 directly but its possible to purchase Index funds that reflect the S&P 500 or invest in the ETF, SPY.
Before the S&P 500, there was the Dow Jones Industrial Average. The Dow and the 30 stocks that are on the Average were the benchmark. The Dow acted as the US leading economic indicator as a result a gauge for the overall economy. It was justly replaced by the S&P 500, which covers more stocks and a larger array of stocks.
Both the S&P 500 and the Dow have one thing very in common. Returns year to year are not consistent nor are they extremely predictable. Among other factors that affect the consistent results of the stock market is inflation.
Stock Market Average Return-Inflation
Inflation can eat away at stock market gains, and capital gains in general. An increased inflation means that investors will require a higher rate of return. Just because they want the higher rate of return doesn’t mean that it will happen! Above we stated that on average, over the past 90 years, the stock market returned 10%. Then if we factor in inflation, on average the stock market has returned 7% over those years.
There is however an issue with the inflation number above. The number is pulled from the CPI (consumer price index). This index is not that trustworthy according to analysts. There is speculation of an underestimation of the inflation rate.
Stock Market Average Return-Historic returns
When analyzing historic returns, its only fair to do it graphically! First we’re going to look at a 5 year period, a 10 year period and a 20 year period. And everything in between! In this example, we’ll be using a $1000 starting balance. We will assume that we start investing in 1998.
Stock Market Return-5 years.
First we’re going to look at a 5 year time frame. The chart below represents the S&P 500 and the blue rectangle is the gain or loss from 1998 to 2003. A 5 year window has resulted in a loss of approximately 6.64%. Neglecting inflation in this example, our initial investment went from $1000 down to $933.60. So far our 10% growth isn’t holding true. Moving onto the 10 year window. If this held true then the balance should have been $1500 by 2003. However if you had taken profit somewhere within those 5 years, you could have come out with a return above the suggest average of 10%. In the midst of these years, the tech bubble popped causing a lot of bearishness. The upside can be attributed to the bubble as well.
Stock Market Return-10 years.
Beneath we have a 10 year chart of the SPX, starting from 1998, holding until 2008. We would expect our money to double, or the S&P 500 to go up 100%. Again the drastic drop during the early 2000’s had a say in the overall average returns expected to occur. The S&P 500 was still bearish over the 10 year period, ending just before the massive crash in 2008-09. There was a 51.50% increase in this 10 year window. Meaning the balance of our invested account would have went from $1000 to $1515. If one was able to pick the bottom early 2000’s move and held it to the top of the 2008 move they would have taken home the 100% return. Unfortunately catching bottoms to ride to the tops is a difficult task.
Stock Market Return-20 years.
Finally, if one held their SPX fund, they would have experienced the 10% average gain that we’ve been talking about. There was a near 200% gain from 1998 to 2018, as anticipated by the average gain. Even with the significant crashes, the 10% average held. This is the first instance we saw that held to our previous hypothesis.
In conclusion, as seen above, there are so many factors that represent the stock markets average return. The longer one held their investment in the market, the more it held true to the average 10% return we assumed. Again this is the S&P 500 so it reflects the US economy. This rule will most likely not apply to other markets.
Factors that affect the overall average returns are duration, inflation and timing. The years we chose are completely arbitrary. Throughout the crashes, a lot of people lost a lot of money and did not get the chance to continue holding their assets. It is also a little less realistic to hold stocks that represent the SPX or an SPX index fund for decades on end.
Retrospectively, the average stock market return is not completely sound, just because the average return is assumed for price action over an extended period of time, nearly a century. This is an average return over that time, every 5 years is different, every 10 is different and so on.
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The information contained in this post is solely for educational purposes, and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable to your own financial situation. TRADEPRO Academy is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.