What Can You Expect From The Market In The Long Run?

The New York Times published a really great chart a couple of years ago that every investor should be familiar with.  They actually got it from Ed Easterling with Crestmont Research.  It demonstrates just how much variation there can be in investment returns depending on what the investing environment looks like over your lifetime.  The chart has apparently been constructed using dividends, average taxes (although the rate is unknown), “average fees” (again unknown) and is adjusted for inflation so these are all real numbers.

This chart shows annualized returns for the S.& P. 500 for every starting year and every ending year since 1920 — nearly 4,000 combinations in all. READ ACROSS THE CHART to see how money invested in a given year performed, depending on when it was withdrawn.
NYT Graph


There are several noteworthy lessons to learn from this chart.  First, in the long run, you would have at least beat inflation by investing in the S&P 500.  Even if you invested at the peaks of the market in The Great Depression, you would have had a positive real return within 20 years (although admittedly that’s still a long time.)

Second, there are three big splotches of red on the chart- the Great Depression, Stagflation in the 1970s, and the 2000s.  Our lost decade is hardly new. The good news is that the dark red splotches don’t go out very far.

Third, there is far more red in the 1970s than there was in the 1930s.  High inflation is a serious foe for an investor.

Fourth, and perhaps most importantly, there just isn’t much green on the chart, especially over long periods of time.  If your investment plan requires 7%+ real returns, you’re probably overly optimistic.  The chart tells me that insofar as the future resembles the past, real long-term returns from US Large Cap stocks should be in the 2-6% range.  Mixing those large cap stocks with assets with lower expected returns like bonds is likely to bring your overall portfolio returns even lower.  Adding some riskier but possibly higher returning assets such as small value stocks or emerging market stocks might increase it somewhat.  My investment plan calls for 5% real returns for my entire portfolio.  After nearly a decade, I’m still trailing that slightly, something around 4.3% last I checked. [Update: I’m over 5% after our recent run.] That’s with a portfolio that has about as many asset classes that are riskier than US large cap stocks as asset classes that are less risky.

Fifth, the market timing that probably matters isn’t something in your control.  If your high earning years (and thus saving years) were in the 1970s, you were just screwed.  You had to either save more or live on less in retirement than those who came a decade before you or a decade after.  If your peak earning years were the 1980s, you had it made in the shade.  If they were, say 1997-2007, then you were hosed.  The unknown variable, of course, is how the chart will look for those of us whose peak earnings years are in the 2010s and 2020s.  I’ll let you know in about 50 years.

Lastly, remember the chart has been adjusted for fees and taxes.  If you can successfully minimize these (something within your control) perhaps you can get a reasonable return even if your peak earning years fall on hard times.  Increasing your return by just 1 or 2% can make a world of difference over the long run.

Comments?  What do you learn by looking at that chart?


What Can You Expect From The Market In The Long Run? — 19 Comments

  1. I wonder how much rabalancing and minimizing taxes (through shelters such as Roth IRAs, 401Ks, and efficient taxable account investing with broad index funds), and maintaining low fees (via vanguard type expens ratios of around 0.25%) affects results.

    You would also need to keep in mind that this graph appears to look at a lump sum investment and what the end result would be for holding periods based on one lump sum investment. I plan on making investments each year for more than 20 years. With that in mind I feel the chances are good that my portfolio as a whole will best inflation, but maybe I’m reading the graph wrong.

    Good thing I plan on investing for more than 20 years at this point. I should at least slightly beat inflation if history continues to repeat itself. And hopefully the things I just mentioned will boost my returns above those depicted in the graph.

    Cool graph regardless.

    • Rebalancing usually just controls risk and doesn’t affect returns. In fact, you’re likely to have lower returns by rebalancing than by letting the winners run. The rebalancing bonus isn’t half what most people think it is. The chart accounts for taxes and fees according to the source, but doesn’t say what the assumed fees or taxes are. Yes, each year is a lump sum investment, just like yours. If you’re curious what the next year’s investment would look like move one line down the graph. Sum them all up to see what your return would have looked like all together.

      [This comment edited to correct an error noted in a comment below.]

    • good posting.. i think i’ve seen from watching Cramer on Mad Money that up to 40% of the total return of the S&P 500 is from re-invested dividends over a 30 year stretch.

      I have a feeling they aren’t taking that into account, just the sheer stock returns.

      The graph reinforces a few things for me:

      1) timing is, as always, everything

      2) all you can do is control the things you can control.. how much you contribute, keeping fees low, dollar cost averaging… and odds are you need to throw more money at it than you think.

      Also, @WCI – i think you started investing at a similar time than I did – 2002.. and your 4.3-5% seems really bad… maybe you have a more prudent plan than i have, maybe i got lucky with a complete market timing exit at dow 11,500 when it was dropping in 2008 and then re-entering around 9000 on the way back up… but it seems low.

    • Yes. They include reinvested dividends.

      Regarding the return, it’s now a little bit higher than the original 4.3% mentioned originally in this article. That was accurate when written, but the market has skyrocketed since then. Alas, I didn’t start my investing career in 2002, I started in 2004, and didn’t start doing it myself until 2005 (so was paying loads prior to that.) It’s a dollar weighted return, so it’s more heavily affected by recent returns than remote returns. Missing out on 2003 probably explains the difference between our returns.

      I’m sure your returns are fine, but I’ve also found the vast majority of investors have no idea how to actually calculate a true return. “Internet returns” are just that. I haven’t updated my spreadsheet for a few weeks but my nominal return from 3/11/2004 to 3/4/2013 was 7.8%, so a real return of a little over 5%. That’s with a 75/25 portfolio.

      • could be.. although i had so little money in the first couple years… but then again by 2006/7 when things took off i probably had more in play.

        But it is definitely possible i haven’t calculated my returns correctly.

        is your return 4.3% total since you started investing, or annualized?

        my brokerage account has really good statistics for this stuff… but my 401k has pretty terrible statistics for this, so i’ve had to do a lot of the calculations on my own.. and admittedly haven’t done them since the close of ’11.. i just haven’t gotten around to 2012 yet…

  2. I like the chart but there are two very important considerations that it does not discuss.
    1. A key point which you do mention in the last paragraph is that these returns were not adjusted for fees, they are pure stock market returns and thus would be applicable only if you were investing the money yourself.

    If one were to invest solely through actively managed mutual funds as most people do through some sort of retirement vehicle, the returns would far less to account for the 1-2% management fees.

    2. More importantly is you have to consider

  3. Sorry for the unfinished response, I hit post by accident.

    The more critical second point is that although the chart makes it seem that solely by investing in the S&P 500 you are likely to beat inflation, it is important to consider that the government grossly understates their inflation measurement. Methodological shifts in government reporting have depressed reported inflation, moving the concept of inflation away from being a measure of the cost of living needed to maintain a constant standard of living.

    Here are some problems with the way the government (The Bureau of Labor Statistics) report inflation as measured by the CPI, or Consumer Price Index.

    1. Decades ago consumer inflation was estimated by measuring price changes in a fixed-weight basket of goods in order to measure the cost of living of maintaining a constant standard of living.

    In recent decades the govt. introduced geometric weighting which reduces the weightings of goods rising in price, and vice versa. In addition, the measure they report is Core-CPI which excludes food and energy from the calculation. What this means is that unless you ride a bike to work and grow your own food, this number does not measure out-of-pocket inflation because the price of commodities are the first thing to rise in price when inflation does occur.

    The price of oil and food has gone up considerably over even just the last few years (look at the price of a gallon of gas or your shopping bill) yet all the while inflation as reported as “under control.”

    2. There is a “hedonic” quality adjustment where they use a computer statistical model to calculate inflation on certain consumer goods. For example, if they deem a computer has become more efficient and better quality, they will make an adjustment based on this and lower the price component of the computer regardless of the price you actually would have to pay for the computer in the store.

    You are entitled to your own opinion, but the govt. purposefully understates CPI for the following reasons.
    1. To reduce cost of living adjustments for government payments to Social Security recipients.
    2. To promote the monetary policy enacted by the Federal Reserve which is to print money to purchase US govt. which is happening now in full force. In this way, our govt. can save some face while “keeping our taxes low” and can use the budget deficit like an ATM machine to get as much money as they want. As long as they report inflation as being under control, they can continue this policy.
    3. By underreporting CPI, the govt. makes the economy look better than it really is and thus we have a higher reported GDP than we would otherwise.

    What this means to you as an investor is that if you are generating 4% returns you may be beating inflation as it is reported, but not really beating inflation. In other words, just because the stock market is making a nominal new high, after being adjusted for inflation you may actually be losing money. The following chart from a fellow trader highlights this important fact.


    • The truth is that all inflation is personal. Over the last 20 years if you’ve spent more money than average on health care or college tuition, than your personal rate of inflation is far higher than CPI. Likewise, if you’re spending more money than the average guy on computers and big screen TVs your rate is likely lower. Renters face a higher personal inflation rate than homeowners whose “rent” is capped.

      Now, as far as the conspiracy theories about the government purposely making inflation appear low, what action are you going to take based on that? Buy more gold? Prefer highly leveraged real estate investments to inflation-linked bonds? Flee to Switzerland? If you want a useful measure of inflation, you have to calculate your own based on what you buy. The rest of us will use CPI and know it might not reflect our own personal inflation rate.

      If you really believed that inflation was 7 or 8% like some people do, then you should be acting very differently- borrowing money like crazy at these low fixed rates and buying real assets on leverage. If you’re not doing that then I would suggest you don’t actually believe it.

      If the rate of inflation is really 3% and not the 2% currently being reported, well, that doesn’t really change anything I do.

  4. I like your idea of personal inflation, it is a good point.

    Let me say that I in no way meant to make this a political discussion and if my comment came across that way it was not intended to do so. I was merely trying to point out that inflation must be taken into account in order to interpret the reported performance of many funds out there especially when fees are taken into account.

    I am not a conspiracy theorist or gold bug but gold is the only asset class that has gone up for each of the last 12 years; stocks, bonds, and real estate have not. I do own gold through the exchange traded fund GLD at times in my personal account.

    I know this doesn’t effect the way you invest but you are much smarter than the average investor and understand the effect that inflation has on your returns. I was trying to make that point a little clearer for you readers so they don’t get fooled into thinking that just because a mutual fund manager shows a 4% return they are beating inflation because after fees they may not be.

    I will make it a point not to discuss anything that could be perceived as political commentary in the future.

    Nice post.



    • I don’t see anything wrong with bringing the subject up. I don’t care if politics are discussed here as long as they are discussed in a civil manner. Whether you’re one of them or not, there are lots of people out there who really do think inflation is really significantly higher than the CPI (like 8% a year.) My point is if you really believe that you should be investing VERY differently from someone who thinks it is around 2%. To be honest, I have no idea if doing hedonic adjustments or leaving out food and energy is a good idea or not.

  5. You mention in your post that fees and average taxes are deducted from these returns, then in your comment you say that they are not reflected in the returns. My interpretation of chart from the NYT site is that the graphed reflect the returns AFTER fees and taxes.

  6. Thanks for the sobering post. In answer to your question, “What do you learn by looking at that chart?”

    I learned that I need to seriously consider the possibility that stocks and bonds are simply not the best investment vehicle for our time. I need to give more consideration to alternative investments, such as commercial real estate, private companies, and tax-lien certificates. Not to say that these alternative investments are not fraught with their own risks, but just that they deserve more consideration than we normally give them, especially in the face of this chart.

      • Wait, Dave is still using 12% annual return? I remember back in the ’90s when he was doing it an it seemed a little high but believable then. Now that would be… rather disingenuous of him.

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