If you're looking to invest in the stock market, understanding average stock market returns is crucial to targeting performance and achieving your financial planning goals. The average annual stock market return is one of the most important critical variables to consider when making long-term equity investments. While making quick approximations can be tempting, it's important to take a closer look at the factors including risk tolerance time horizon and diversification.
Determining a good benchmark for your portfolio depends on various factors, including your investment goals and risk tolerance. It's important to understand average stock market returns as they can serve as a baseline for evaluating your portfolio's performance over time. By analyzing historical data and considering key factors such as inflation rates and economic growth, you can gain a deeper understanding of what to expect from the stock market in the long run. In this comprehensive guide, we'll cover everything you need to know about mastering average stock market returns - from calculating them accurately to using them effectively in your investment strategy.
The Key to Understanding Average Stock Market Returns
The average stock market return is a measure of how much money investors can expect to make in the long run. It's important to understand that this number is an average and does not necessarily reflect the actual returns of individual investors. As a result, investors should be strategic in their investment goals and consider factors such as risk tolerance, time horizon, and diversification when building their portfolio. By doing so, they can increase their chances of achieving their desired returns and ultimately reach their investment goal.
What Is a Stock Market Return?
What Is a Stock Market Return? A stock market return refers to the profit an investor receives from owning shares of a publicly traded company. The return can come in two forms: capital appreciation or dividends. Capital appreciation is the increase in the stock's price over time, while dividends are payments made by a company to its shareholders. It's important to understand stock market returns because they can indicate how well your investments are performing. However, it's also important to remember that the stock market fluctuates and past performance does not guarantee future results.
Discover the Truth About Losing Money in Stocks
Investing in stocks can be a risky business, and anyone who tells you otherwise is lying. Damodaran's data reminds us that over the 94 years covered by his analysis, there were plenty of declines that weren't just part of a terrible decade. But there were also winning streaks, where investment jumped with double-digit gains year after year.
Reinvested dividends made a big difference to stock investors during those 94 years, especially when we consider the Great Recession and the dot-com crash. Damodaran's data shows that even though investment declined during these times, reinvested dividends helped soften the blow. Despite these setbacks, it's still worth remembering that over 25 years, there's roughly a 1-in-2 chance of losing money in stocks.
So what's the takeaway from all this? The annualized return for stocks over those 94 years was around 10%, which is pretty good considering all the ups and downs along the way. However, it's important to note that there were still roughly four one-year periods where investors lost money for every three where they gained. If you're willing to take on some risk and stick with it for the long haul, then investing in stocks may be right for you.
Average Stock Market Return for the S&P 500
Average stock market returns depend on a variety of factors, including economic conditions, geopolitical events, and investor sentiment. However, over the long haul, stocks have historically provided strong annualized returns. Since 1957 fortunately, the S&P 500 has been closely tracked and analyzed by Nobel Prize-winning economist Robert Shiller.
Shiller's data reveals that since 1957 with dividends reinvested, the S&P 500 has delivered an average annualized return of around 10%. This means that if you had invested $1,000 in the S&P 500 in 1957 and held onto it until today, your investment would be worth approximately $1.9 million. Of course, over the years stocks have experienced periods of volatility and downturns which can impact the annualized return.
Despite this volatility, investing in stocks over a longer period has still proven to provide solid gains for investors. According to Shiller's data again from 1926 through to today with dividends reinvested, the average earned annualized stock market return was about 9.8%. These figures demonstrate that despite short-term fluctuations in the stock market and individual stock performance, investing in stocks remains one of the best ways to build wealth over time.
Discovering the Origin of the Rule of Thumb
Have you ever heard the phrase "rule of thumb"? It's often used to describe a general guideline or rough estimate. What many people don't know is that this saying actually has roots in the stock market. The rule of thumb reflects the average annual historical return of the stock market, typically measured by indices such as the S&P 500 or Dow Jones Industrial Average. These indices track some of the largest companies in the United States across 11 sectors, with the S&P 500 being one of the most widely recognized and consisting of 500 companies with a focus on large-cap stocks. Another popular index is the S&P MidCap 400® and SmallCap 600®, which provide insight into mid-sized and small-sized companies respectively. One other common index is the Russell 2000, which measures performance of smaller-cap U.S. stocks.
Why the S&P 500 Average Return Is Rarely ‘Average’
The S&P 500 Average Return is often referred to as the "annual average" of stock market returns, but this number can be deceiving. While it may seem like a reliable indicator of what to expect from the stock market in a specific year, the reality is that this average can vary greatly from one year to the next.
In fact, over the past 20 years, there have been several instances where the annual average return has been significantly higher or lower than what would be considered an "average stock market return." This is because some years are simply better than others when it comes to investing, and there are always negative outliers.
Despite these bad years, however, many investors still look at the 20-year average return as a way to gauge overall performance. While this may provide some insight into how stocks have performed over time, it's important to remember that individual results will always vary based on factors like timing and individual investment strategies.
1. Dot-Com Bubble
The late 1990s were a time of immense growth for website-based companies, which became hugely popular with investors. These dot-com bubble stocks experienced a meteoric rise in value, but it was short-lived. When the market experienced huge sell orders, investors started panic-selling and the dot-com bust ensued. This is one of the perfect examples of how the stock market can be unpredictable and risky. The market experienced annual losses, with an average annual loss of 9%, and in 2001 returns dropped by a staggering 11%.
2. Financial Crisis of 2008
The financial crisis of 2008 was caused by years of banks giving unconventional loans to low-income individuals with bad credit, allowing them to buy homes as housing prices increased drastically. When the market crashed, these people could no longer afford their homes, putting lenders in a tough spot. The Fed proposed a bank bailout bill, but Congress denied it, resulting in a year-long stock market fall that Congress couldn't immediately undo.
3. Market Recovery
Despite the dot-com bust and financial crisis being prime examples of events that caused stock returns to plummet, the market has always bounced back. After steep drops in the early 2000s, tensions finally started to ease in late 2003 and the stock market soared. Since then, year on year annual average returns continued to trend upward, with consecutive annual gains. While there are negative outliers in any market recovery, it's important to remember that the stock market experiences ups and downs but playing the long game pays off - as evidenced by average stock market returns dating back decades.
How to Use the Average Stock Market Return
The stock market returned an average annual return of around 10% over the past 30 years. This information can be used for long-term planning purposes such as saving for retirement or a child's education. By calculating your target amount and factoring in the average return, you can determine how much you need to save on an annual basis to reach your goal.
If you had started saving 10 years earlier, you'd have considerably more buying power due to compound interest. On a monthly basis, interestingly enough, the difference between starting early and starting later is not significant. However, over time, that small difference in effective return can make a big impact on reaching your goals.
It's important to consider your time horizon and risk tolerance when using the average return as a guide for subsequent investments. Be sure to factor in management fees, expenses and taxes which can all affect your net returns. In summary, the average return can be a useful tool for estimating potential growth but should be used in conjunction with other investment strategies and financial analysis tools.
1. Time Horizon
Your time horizon is a crucial factor when considering investing in the stock market. If you're planning on investing for 30 years or more, using the long-term average stock market return of 7-8% as a reasonable starting point is helpful. Keep in mind that short-term stock market returns rarely match long-term averages and that market performance can be unpredictable, especially during financial crises like the years ending in 2008 and 2020. By focusing on asset allocation and creating a diversified portfolio, you'll improve your chances of achieving a similar return over the long haul.
Note: When it comes to the average stock market return, the "rule of thumb" doesn't work for everyone. Those with shorter time horizons, such as those saving for a tuition bill or planning for their children's lives, need to choose investments that ensure they'll meet their financial goals. Drew Kavanaugh, Vice President of wealth advisory firm Odyssey Group Wealth gave some advice on this matter by suggesting to invest long term and risk early in order to combat wide market swings that can lead to lower long-term returns. Savings aren't enough anymore amidst wild market fluctuations, so it's important to take action now.
3. Risk Tolerance
Risk tolerance is an important factor to consider when investing in the stock market. It refers to how comfortable you are with the ups and downs long term. Knowing your risk tolerance can help determine how much of your portfolios asset allocation should be in stocks versus bonds or other investments. Realizing long-term gains depends on staying invested even during downturns, but if you're losing money and can't handle large gains, it may be time to reassess your risk tolerance.
Frequently Asked Questions
How do you calculate average return?
To calculate average return, add up all the returns and divide by the number of periods. For example, if you had returns of 5%, 10%, and -2% over three years, you would add them together (5% + 10% - 2% = 13%) and divide by three to get an average return of 4.33%.
What is the average annual return of the S&P 500?
The average annual return of the S&P 500 over the past 50 years is around 10%. However, this can vary greatly in any given year or time period based on market performance.
How much do you need to invest in stocks?
The amount you need to invest in stocks depends on your financial goals and risk tolerance. It's important to do your research, set a budget, and start with small amounts before investing larger sums of money.
Are stocks up or down?
Stocks can either be up or down depending on various factors such as economic indicators, corporate earnings reports, and global events. It is important to stay updated with the latest market trends by following reputable financial news sources.
Why do stocks keep going up?
Stocks keep going up due to various factors such as strong corporate earnings, low interest rates, and optimism about the economy. However, it's important to note that there can also be periods of market volatility and downturns.