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.
Very interesting question. It depends on what time period is used. For example, the average annual return from August 1982 to March 2000 was 12.2%. That was a long secular bull market. From March 2000 July 2016 the return is less than 3%. If you look at the secular bull markets since 1900 to the end of 2000, it seems like the average return has increased for each successive secular bull, but the time has been shorter. Take for example the 1941 to 1966 time the S&P increased approximately 10 fold in 25 years. The secular bull from 1982 to 2000 was an increase of 10 fold in 18 years. The question is whether we entered a new long-term secular bull market in 2010 or 2011 and how long will it last. I believe we did and the duration will be less than 18 years.
By the way, 10% will double in 7 years, not 10.
There is one other factor to consider in all this. Things are changing ever more rapidly. The companies that made up the S&P 500 in 1920 had an average life of 70 years before they died (think Eastman Kodak, Woolworth, Union Carbide, etc.). Today the average life of a company in the S&P 500 is less than 20 years and is approaching 15 years.
Let me ask you a question. If you started with a penny and each time you received twice what you had the day before, how much money would you have at the end of 30 days? Take a guess before you read further.
You would have over $10 million at the end of 30 days. But, 1/2 of that came the last day. 75% came the last two days. 90% came the last 4 days. The curve in the beginning looked like a flat line. It is only when the curve turns sharply upward that you realize it is exponential.
Is the S&P going to look like an exponentially increasing curve? I think an argument can be made it is showing that characteristic. And the speed of turnover seems to validate that.
While many market pundits are publicizing a view that returns are going to be significantly lower than history, I believe they are going to be shocked with what the returns will actually be. The danger is investors who buy into the view of lower returns. Instead of firing their advisor for lousy results they will keep the advisor because the so-called experts said to expect low returns.