Most of the investing calculations I do here at Free Money Finance use 10% as the suggested/estimated annual return. Why is this? Mainly because it's easy to use and it's representative of annual average stock returns through decades of tracking. That said, every once in awhile someone will comment that 10% is not a realistic number to use (it's too high.) Here are the facts on stock growth from USA Today:
Since 1927, the S&P 500 stock index has gained 10.4% a year on average.
Subtract 0.4% (or less) for the cost of a market-based index fund and you have 10% even. It's that simple.
That said, this information doesn't imply that you'll get exactly a 10% return in every year. In fact, the actual results in any given year are usually far from 10%. More from USA Today:
It's important to remember that this doesn't mean the stock market returns exactly 10% a year, every year. It's actually unusual for the market to return exactly 10% in a given year. The S&P 500 has only posted a return of between 10.0% and 10.9% four times since 1926 and only returned exactly 10% once, in 1966, according to S&P data that includes dividends. In any given year it could be up 29.9% or down 9.0% or somewhere in between, says IFA.com.
So you have to be willing to ride out the ups and downs -- buying more at the lows and enjoying the highs (and wishing they would continue.) ;-)
While the stock market has climbed an average of 10% annually, that is no guarantee that the stock market will grow at that pace over the next 80 years.
Consider the following excerpt that I found at
http://homepage.mac.com/j.norstad/finance
/rtm-and-forecasting.html
The article states that the following statements are true:
(1) Returns from 1930-2005 fluctuated around the mean return measured over 1930-2005.
(2) Returns from 2005-2080 will fluctuate around the mean return measured over 2005-2080.
Common sense starts with these facts and leaps to the following conclusion:
(3) Returns from 2005-2080 will fluctuate around the mean return measured over 1930-2005.
However, (3) is not a necessary consequence of (1) and (2). Statements (1) and (2) are true but trivial.
Therefore, whenever I am considering financial decisions, I approach it with a conservative mindset (aim for a 5% annual return in the stock market), instead of banking on 10% returns.
Just my 2 cents.
--Matthew Rosenthal
Posted by: Matthew Rosenthal | February 15, 2007 at 08:27 AM
Why do all of these figure look at the stock market since 1927? Is what happened 80 years ago really relevant to today's market? There have been many changes since then, dollar taken off the gold standard, globalization of the economy. etc. I'd be more interested in the average since 1977.
Scott.
Posted by: Scott Wincklhofer | February 15, 2007 at 10:00 AM
With a quick look at Yahoo charts for the S&P and a quick spreadsheet it looks like the S&P averaged 9.17% from 1977 to today.
Scott.
Posted by: Scott Wincklhofer | February 15, 2007 at 10:13 AM