Between 1950 and 2021, the average annual return of the S&P 500 was 10.13%. Few asset classes have delivered such terrific results over a multi-decade time horizon.
While it’s technically true that the stock market delivers an average return of 10% per year, it’s a mistake to get too anchored to that number. Here’s why.
Not all averages are created equal
Some averages can be very useful. Average miles per gallon on a highway is a good indicator of fuel efficiency for a car. A field goal shooting percentage in basketball is the product of hundreds, if not thousands, of shot attempts in a season. And in baseball, a batting average for even just one season is the result of hundreds of at-bats in a set environment the same distance from the pitching mound. Yes, there are different umpires and pitchers per at bat. But it’s a metric that is reliable, given the consistency of the setting and the sample size.
The stock market’s average couldn’t be more different. Not only is the sample size relatively small, but the economy has changed so much in the last 10 years alone. What’s more, how the stock market performed in the years prior can heavily influence its performance in a given year.
For example, the S&P 500 delivered a -17.4% return in 1973 and then a -29.7% return in 1974, which left it undervalued and poised for a 31.6% return in 1975 and then a 19.15% return in 1976. The same goes for the post-dot-com rally in the Nasdaq Composite or the S&P 500’s torrid growth rate since the financial crisis.
Each year in the stock market is a mixed bag of long-term themes that are playing out in real time and short-term tailwinds or headwinds. For example, in 2018 we had the U.S.-China trade war clash with strong earnings. 2018’s 6.2% decline was followed by a 29.9% gain in 2019 thanks to low interest rates and strong earnings growth. 2020 brought the pandemic, but the market gained 16.3% anyway thanks to multi-decade-low mortgage interest rates, stimulus, and the belief that the issue was temporary.
2021 played off that momentum with a 26.9% gain. And this year, rising interest rates, rising mortgage interest rates, record home prices, inflation, and geopolitical tensions on top of what was a relatively expensive market have led to losses so far.
In sum, no single year in the stock market is the same. And that makes for big variations in the average return.
This chart shows S&P 500 returns (not including dividends) for each year between 1950 and 2021. The mean return is, as mentioned, 10.13%. The median is 12.36%. And the standard deviation is 16.04 percentage points.
The red bars show the return that year, and the two light blue lines show the range between one standard deviation above and one standard deviation below the median.
To illustrate just how large a standard deviation of 16 percentage points is, consider around one out of every three years is going to have a return of worse than -5.9% or greater than 26.2%. And roughly one out of every 20 years is going to have a return of worse than -21.95% or greater than 42.22%
Estimate of Data Points in This Range
To further show why it’s hard to have a “normal” year in the stock market, consider that just seven out of the last 71 years had an annual return between 8% and 12% — in 1952, 1959, 1965, 1971, 2004, 2014, and 2016.
Lessons from the data
The data tells us that we should basically never expect the stock market to return 10%, let alone between 8% and 12%. Rather, we should expect massive swings in annual performance that oftentimes involve some brutal downturns but also some big up years.
The secret to generating lasting long-term wealth is to outlast market gyrations and develop a habit of saving. It may be comforting to hear that starting with $0 and saving $10,000 a year in a retirement account for 50 years at a 10% compound annual growth rate will result in $11.64 million — life-changing wealth from a relatively reasonable savings plan.
One of my favorite Warren Buffett quotes is: “Time is your friend; impulse is your enemy. Take advantage of compound interest, and don’t be captivated by the siren song of the market.” It teaches us that staying even-keeled with a balanced temperament is one of the best ways to respond to a market that keeps doing crazy things.
Hopefully, this article leaves you with a more realistic expectation of what to expect from the stock market in any given year — while also reaffirming the long-term power of compound interest.
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