Since the financial crisis of 2008, two dominant views on stock market investing have emerged:
- Stock market investing is volatile and risky, akin to gambling.
- Stock market investing is reliable and free money.
The Great Recession produced a decline in overall equity values in the range of 50%+ from 2007 to early 2009. The event created a lasting and widespread change in mindsets around personal finance, even what it means to be securely middle class. However, for those that stayed the course, the subsequent Great Bull Market produced exorbitant wealth for almost anyone investing in almost anything.
If there’s a lesson to be learned here, it’s that market growth and declines are cyclical. These cycles are influenced by a complex blend of fiscal policy, business practices, and perhaps most important of all—animal spirits: human behavior and emotion. To balance risk and reward, one should invest broadly in the market as a whole and increase the investing timeline. The latter in particular is easier said than done. In this post today, we quantify the power of longevity in the market. We have reason to rejoice, so long as we can hang on!
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Origin
This post is an extension of my answer to a question raised in my Q&A 10. The listener correctly pointed out that financial independence bloggers, including myself, often use simplified charts or calculators like the one below to highlight an ideal timeline to financial independence. This timeline assumes a certain savings rate (with the caveat that all those savings are being invested) and an estimated yearly return.
It’s a simple model. And simple models make broader assumptions than their complex counterparts. That said, simplicity is useful for whetting the appetite, but as with many things, the devil is in the details.
What Yearly Return Should I Use?
You’ll commonly hear financial bloggers throw around yearly whole-market returns of roughly 7-12%. Why the variation? Well, it probably depends on whether the figures being cited account for inflation (which reduce market returns) or dividend reinvestment (which increase market returns). Or, if you are like me, you’ve probably just regurgitated what you’ve heard or read somewhere else.
So, if I save 50% of my money and invest it in something that makes a flat, wonderful, and predictable return of 7% per year, (and with a 4% withdrawal rate, and starting from a net worth of $0, and assuming a flat retirement spending profile), my working life is only 15 years!
But life—and by extension the stock market—is not flat nor is it predictable. Since the end of 2021, folks are not only failing to get anything close to 7%, but they’ve actually been losing money! The inflation-adjusted return of the S&P 500 in 2022, assuming dividends were reinvested, was a grim -22.8%.
So, are these predictive savings/retirement timeline charts and figures unfair? No, they’re not. They are just simple models that use long-term averages because that is the best we can do with an unknowable future, at least when we want a back-of-the-napkin answer. But the question everyone wants answered is what will my investing horizon provide?
S&P 500 Yearly Returns
In an attempt to answer that question, I analyzed the S&P 500 yearly returns dating from 1928-2022, calculated on the final trading day of each year. Yearly returns are highly variable. When accounting for inflation-adjusted returns with dividends reinvested, the following is observed:
- Max = 53.8%
- Min = -37.1%
- Average = 8.7%
- STDEV = 19.5%
- n = 96
So, since 1928, one could have lost nearly 40% or gained over 50% of their money in any given year.*
A standard deviation of nearly 20% tells us what we already know: there is a wide variation on expected outcomes on any given year in the S&P 500. However, the average yearly return is a pleasant 8.7%. Also noteworthy is that 67% of yearly returns were positive, while only 33% of yearly returns were negative.
The long-term investor who held a broad-based position in the market, through all the trials and tribulations of the world since 1928—and the list is long—was rewarded with a 9% yearly return on their investment. $1,000 invested in 1928 would now be worth in excess of $2,500,000.
*It’s important to realize that highs or lows within the year being analyzed weren’t captured; these returns are simply a calendar year return. For instance, the stock market lost approximately 30% in February and March of 2020, but those losses were recouped by the end of the year to produce a positive yearly return for the calendar year.
Stock Market Rolling 10-Year Returns
As the investing timeline increases, volatility and variability decrease. As we discussed on the section above, yearly returns are highly variable and can swing dramatically from year to year, although positive years are roughly twice as prevalent in the historical dataset.
To analyze 10-year returns, a moving 10-year average was calculated on inflation-adjusted S&P 500 returns, assuming dividends are reinvested.
Results:
Rolling 10-year Returns (inflation-adjusted, dividends reinvested)
- Max = 19.5% (1948-1958)
- Min = -1.9% (1964-1974, close second is 1998-2008)
- Average = 8.9%
- STDEV = 5.1%
- n = 86
With this dataset, compared to the yearly returns, a few conclusions jump off the page.
- The highs aren’t as high, but the lows aren’t as low.
- The average, at 8.9% has hardly budged.
- The standard deviation is much lower. In other words, the range of expected outcomes on a 10-year investing timeline is much narrower than one could expect on any given year. Over any 10-year investing timeline, an investor is very likely to see yearly returns between 3.8% – 14% (average +/- standard deviation). However, as our friends from the late 60s and early 70s or the Dot Com/housing crisis can tell us, negative 10-year yearly returns are precedented.
Using the Rolling 10-Year Data to Predict a Future Return
So, if I were beginning my investing journey and wondering what my net worth might be in 10 years, I’d first punch the average (8.9%) into a compound interest calculator. But in the interest of due diligence, I’d run some upside and downside sensitivities, using the maximum and minimum observed yearly returns (historical worst case and base case scenarios), and the more likely standard deviation range. Or, one could punch in the standard deviation (5.1%) as a variation on the average to get an idea at the most likely range of outcomes.
My wife and I started investing in 2011. Our 10-year yearly average return was roughly 12.5% using this dataset. So, while this return was above average, it wasn’t statistically exceptional, lying well within one standard deviation of the average. We were able to reach financial independence quicker than most calculators would suggest because of these above-average returns. In that sense we were lucky, but not too lucky.
Stock Market Rolling 20-Year Returns
Perhaps expectedly, as we analyze a rolling 20-year window of yearly S&P 500 returns, continued reduction in volatility and variability is observed.
Results:
Rolling 20-year Returns (inflation-adjusted, dividends reinvested)
- Max = 14.7% (1941-1961, close 2nd and 3rd is 1979-1999 and 1948-1968)
- Min = 2.6% (1961-1981)
- Average = 8.9%
- STDEV = 3.2%
- n = 76
Once again, lower highs and higher lows are observed when the investing timeframe is expanded. Of note: over a 20-year rolling average, there have never been negative yearly returns. The worst-case scenario is a yearly return of 2.6% (remember: inflation and dividend reinvestment are already accounted for in these figures).
The average is still hovering just under 9%, but the standard deviation has tightened down to 3.2%. That tells us that we can have more confidence in seeing 20-year returns closer to the long-term average, likely in the range of 5.7% – 12.1% per year.
Stock Market Rolling 30-Year Returns
The pattern continues: the longer the investing timeline, the closer we revert to the average long-term performance.
Results:
Rolling 30-year Returns (inflation-adjusted, dividends reinvested)
- Max = 13.1% (1931-1961) Those who started investing during Great Depression did best!
- Min = 5.9% (1964-1994)
- Average = 9.0%
- STDEV = 1.7%
- n = 66
Performance is looking rosier. Our average yearly return is 9%, and we are very likely to see yearly average returns between 7.3% – 10.7%. I’d take that any day.
Stock Market Rolling 40-Year Returns
Once our investing timeline is long enough, now at 40 years, we’re starting to see a much higher degree of predictability. Tighten up and tuck those tails!
Results:
Rolling 40-year Returns (inflation-adjusted, dividends reinvested)
- Max = 11.3% (1932-1972, 1981-2021 is close 2nd)
- Min = 6.1% (1968-2008)
- Average = 8.6%
- STDEV = 1.1%
- n = 56
Our average has dropped a bit, to about 8.6%. That’s because there are far fewer years to analyze with a 40-year investing timeline (56 40-year windows). But from the available data, we can be much more confident that our investments will return something very close to the long-term average, with returns likely between 7.5% – 9.7% per year.
Some might be bummed to see that as the investing timeframe increases, the upside return case seems to diminish. Well, that’s true. But what’s also true, and most important to me, is that the low-side risk is much diminished. The worst average yearly return observed from this dataset over a 40-year window is 6.1%, which I’d also note is a 3-standard deviation event (i.e., an outlier).
Let’s Talk About Dividends
One key caveat and assumption in this analysis is that the investor is reinvesting dividends during wealth accumulation.
Reinvesting dividends is a superpower to increasing long-term performance. On average, since 1928 dividend reinvestment has increased the value of the yearly return by around 4%, which is huge! That said, dividends have been falling for years, and the last 20 years have netted roughly 2%, on average.
Once the accumulation phase is over and one is living on investments, it makes sense to then spend dividends instead of reinvesting. But during the savings years, be sure to reinvest dividends in all accounts.
Summarizing Figures
It’s clear that investing longevity in the broader market rewards those who stay the path. Investing over short time frames, or engaging in market timing, can produce wildly variable results. Because this practice is so common, the narrative of a risky and volatile stock market persists.
However, as with many trends in nature, high frequency volatility is smoothed over time. An investor who buys a broad-based index fund and holds it for 10 or more years can have a much higher chance of performing near the long-term average, which in this case is a shade under 9% per year (remember, we have already accounted for inflation and dividend reinvestment). That’s a fantastic return! But for those only a handful of years into their investing, such a return is far from certain.
For those early in their planning, I’d recommend starting with an average yearly return, but use some of these minimum, maximum, and standard deviation cases to get an idea of the range of possible outcomes. If you have any questions, drop them below.
The key caveat is that these observations correspond to past performance. Future performance is not guaranteed.