Are you using a 10% return for stock market projections?
If you’re like me and you use a 10% return when figuring out investment returns, maybe you shouldn’t be. Whenever I’m using one of those online investment return calculators or whatever, I typically use a 10% return for an all-equity model. I’ve read numerous places (here’s one example) something to the effect of “the U.S. equity markets returned an average of 10% over the last century.” It’s one of those conventional wisdom things in personal finance.
I was looking over the prospectus of an S&P 500 Index fund we invest in. It showed the average annual return over the past 10 years. According to this table, the S&P 500 returned 8.42%, this fund returned 8.11% before taxes, and 6.93% after taxes and sale of fund shares. If I’m not mistaken, 8.42% is still less than 10%. And, yeah, I know the last 10 years is not the same as the last 100. But note that the period 1996-2006 included two significant bull markets.
S&P 500 10 Year Chart
My point is that maybe 10% isn’t a very realistic number for modeling your stock investments. Then I read this post from Lazy Man saying he’s read stuff saying the market returns 12%. How can there be this wide a variance in reported returns? It should be a simple statement of fact that “the S&P 500 returned X% over the last 80 years.”
So what’s the answer? For me, I’ll be using eight or maybe nine percent for my models from now on.
May 18th, 2007 at 11:29 am
I use 6%, because I’m a pessimist. Besides, any figure will be wrong. Likely very wrong. I’d rather be wrong on the low side than the high side.
Regarding disparities in past peformance, I think there are several factors:
* Saying “the market” returns 12% is a different metric than saying the S&P 500 returns 10% (or 8%).
* Some figures include dividends, some include only capital appreciation.
* The figures a fund reports probably include expenses (of course those should be low for an S&P 500 fund)
* The time frame — the numbers you were looking at were over 10 years, but that’s a pretty short sample.
May 18th, 2007 at 11:51 am
Samerwriter, you’re right on all counts of course.
May 18th, 2007 at 12:23 pm
Also don’t forget the difference between real returns and absolute returns….assumng 2% inflation 12% IS 10%..
To samerwriter - note that being too pessimistic is ALSO a risk. It could lead you to change your debt/equity allocations and thereby give up a LOT of long term gains. For what it is worth I use 7.2% or so, that I lifted from David Swensen.
May 18th, 2007 at 12:50 pm
I’ll be using 10%. I think the higher the better. I’m a pretty young and aggressive investor and the higher percentages keep me from being too conservative… not to the point of dumb risks though
May 18th, 2007 at 3:19 pm
May 18th, 2007 at 3:21 pm
I use 8% for the very reason you wrote about.
May 18th, 2007 at 7:24 pm
May 18th, 2007 at 7:55 pm
I used to be on the more conservative side as well. I would go with 5.5% after inflation (8%-2.5%). However, two pieces of information has swayed me. Vanguard’s S&P 500 has returned 12+% since 1976 (inception) and JLP of AllFinancialMatters has crunched the numbers himself, using what I believe is the SBBI Yearbook. JLP is a finance professional (I believe), so I trust his calculations. In that he notes that the REAL returns (after inflation) for the S&P 500 were 9.22% since 1926.
There are two things to note here. 1) These are significantly long time periods, which is probably a better sample size than say, the last 10 years. 2) It is only the S&P 500 measured. As Samerwriter says, it’s not “the market”. However, returns on small caps are supposed to have higher returns than large caps (countless sources say this is true, I don’t have the time/space to go into it hear) and the S&P 500 has just finally got to the point of topping new highs while the Dow has been doing it for some time. This suggests that the largest caps have outperformed the S&P along with the small caps. Thus while the S&P 500 might not be “the market” it stands to reason that it’s in the range of the average market returns. Some things probably perform worse, but there are certainly some things that perform better.
May 19th, 2007 at 8:37 am
Historic numbers for 1927-2006:
Large Cap: 10.41% (S&P500)
Large Cap Growth: 9.34%
Large Cap Value: 11.54%
Small Cap: 12.05%
Small Cap Growth: 9.33%
Small Cap Value: 14.51%
Microcap: ~13%
Historic numbers for 1945-1992:
Emerging Market: 16%
Prorating emerging market to the longer 1927-2006 period will drop the return to about 14% (based on percentage drops for Large Caps & Small Caps).
May 20th, 2007 at 10:04 pm
I am quite aggressive with what little money I have, so 10% is achievable for me.