- It’s somehow accepted that stock returns have been between 8% and 10% in the past. That is correct, but only for a short period in history and it’s not true for all markets.
- We’ll discuss stock returns over the past 100 years globally which will paint a different picture than what the predominant opinion would have you believe.
- This doesn’t mean stocks are bad investments, you just have to understand how to go about them. After all, it’s your financial life on the line.
Currently, most financial advisors will state that the best rational investing pattern is to invest in index funds as it’s impossible to beat the market, and that index funds have been a great investment vehicle over time.
That would be a correct statement, but the returns that are noted by those who are trying to sell you an index fund are cherry-picked from historical examples. But the truth looks a little different.
If we look at inflation adjusted returns for the S&P 500 index from 1881 through today, there are decades-long periods where real stock market returns have been negative.
So from 1881 to 2017, there has been one period of 78 years, from 1905 to 1982, where the real return on stocks was zero. I’ll bet you’ve never heard that from anyone selling stock market index funds to you.
Periods of 30 years are even more common, and lost decades are the norm. Thus, when somebody flashes historical stock market returns of 10%, do yourself a favor and understand that what has happened in the past doesn’t necessarily happen in the future.
If you look back at the previous figure, you can see that the bulk of positive stock market returns have happened in the last 35 years. There’s a simple explanation for that. Interest rates have been continually declining.
Lower interest rates make the value of all assets go up as the expected return from those assets declines. In the figure below, you can see how home prices have benefited from lower interest rates. As interest rates decline, home prices and stocks rise.
Further, the typical 8% to 10% returns marketed by the more conscious financial advisors has only been achieved in a handful of markets.
It’s interesting how returns in Italy have only been 1.7% per year, 3.2% for Spain, and even negative in Austria with -0.6%. The 6.3% yearly return achieved by U.S. stocks is more of an outlier. Don’t be confused by the 6.9% global return as many markets didn’t even have a stock exchange for most of the period. Nevertheless, all the above still paints a positive picture with mostly positive returns. However, a look at the returns from investing at the worst possible time paints a completely different picture.
The best 10-year return from investing at a market peak is -28.8% from the New Zealand market, while the worst 10-year returns go beyond -90% in many cases.
The worst one-year decline averages are above -50%, and 3-year declines are above -60%. If you’re invested in the stock market or any other investment class, you have to expect it to fall around 70% at least once in your lifetime. I’m not making that up. I’m quoting Ray Dalio here. So it’s very important that you understand the risks of investing in stocks. I’d venture to bet that whoever sold you on index funds didn’t tell you any of this.
What Should You Do With All This
I believe that the main reason for the mass obsession with index funds is financial responsibility.
By investing in index funds, you simply hand over your financial wellbeing to your banker, advisor, or whomever convinced you stocks are the best investment. The problem is that the person that sold you those investing vehicles gets paid a commission when they sell you something and then get a cut of your portfolio no matter the performance. So think about that and consider taking responsibility for your financial future.
How To Take Responsibility Of Your Financial Future
The first thing to do is to understand investing. It takes some time, but it pays of massively.
I’m baffled by the fact that many investors spend 15 years or more and thousands on their education in order get a job and make a few million over a their working lifetime but aren’t willing to spend any time with their banker once a year to learn about investing. The results of that are terrible for two reasons.
The first reason is discussed above. The likelihood that stocks deliver the same returns in the next 35 years as they have in the past 35 years is close to zero as interest rates don’t have much room to go down.
The second reason isn’t that obvious, but it’s perhaps even more important.
The expected long-term market return is 4% for the next decade (Ray Dalio again, not me). If you invest $1,000 per month in your IRA or any other kind of investment vehicle, over 35 years, you will have a portfolio of $899,919 which isn’t bad at all as the total investment is $420,000. The fact that the return is positive and attractive makes most forget about the other option.
I strongly believe that by taking responsibility for your financial wellbeing, it’s possible to lower your investing risk and reach long term returns of 10%. With the same $1,000 per month invested over 35 years with a 10% yearly return would give you $3.4 million, which is a staggering $2.6 million difference.
Keep reading Investiv Daily as I’m always discussing the necessary mindset and the ways to achieve 10% or more yearly returns.