A:

According to historical records, the average annual return for the S&P 500 since its inception in 1928 through 2014 is approximately 10%. However, that number can be very misleading. If an investor thinks that translates to just putting money in the S&P 500 Index and watching it double about every 10 years, he is likely in for a rather big disappointment. Accurate calculations of average returns, taking all significant factors into account, can be challenging.

The S&P 500 is a collection of 500 stocks intended to reflect the overall return characteristics of the stock market as a whole. The stocks that make up the S&P 500 are selected by market capitalization, liquidity and industry. Companies to be included in the S&P are selected by the S&P 500 Index Committee, which consists of a group of analysts employed by Standard & Poor's.

The index primarily mirrors the overall performance of large-cap stocks. The S&P 500 is considered by analysts to be a leading economic indicator for both the stock market and the U.S. economy. The 30 stocks that make up the Dow Jones Industrial Average were previously considered the primary benchmark indicator for U.S. equities, but the S&P 500, a much larger and more diverse group of stocks, has supplanted it in that role over time.

It's difficult for most individual investors to actually be invested in the S&P 500 since that would involve buying 500 stocks. However, investors can easily mirror the index's performance by investing in an S&P 500 Index mutual fund or exchange-traded fund.

One of the major problems for an investor looking at that 10% average return figure and mistakenly expecting to realize a nice yearly profit from investing in the S&P 500 is inflation. Adjusted for inflation, the historical average annual return is only around 7%. There is an additional problem posed by the question of whether that inflation-adjusted average is accurate since the adjustment is done using the inflation figures from the Consumer Price Index (CPI), whose numbers many analysts believe vastly understate the true inflation rate.

For an individual's investment success, when he chooses to enter the market makes a significant difference. The stock market performed very well for an investor who bought stocks between 1950 and 1965, but the market was nothing but a continuous 15-year disappointment for an investor who entered in 1965. The market's best sustained performance was from 1983 to 2000.

A significant detail about the historical S&P returns is that nearly half, over 40%, of the gains made over the years come from dividends. Calculating in the effect of an investor reinvesting all dividends received would render the historical performance figure substantially higher.

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