What Risk and Return Should I Expect From My S&P 500 Index Fund

“The stock market, on average, returns 8% per year”. You’ve heard that statement probably a thousand times before. If you’ve been reading this blog, you’ve heard it here as well. But there is a lot of data and questions buried by that 8% figure. Should I expect that return every year? What is the worst I can expect? Does investing for longer periods of time increase my changes of earning 8% on my investments? I want to do some statistical analysis to show you the relationship between time, reduced risk, and reasonable expectations of your investment returns.

In the below graph, I show historically how the stock market has performed over a 1-30 year period going back to January, 1950 (the earliest data I had available). By that I mean, from January 1, 1950 to January 1, 1951, what was the return. Then what was the return from February 1, 1950 to February 1, 1951, etc. up through August 2017. Then I looked at the 2-year returns (January 1, 1950 to January 1, 1952) and so on until the 30 year horizon. Plotting the maximum return, the minimum return and the average return presents some very interesting information to show you what you can expect while investing and why investing for long periods of time is so important for mitigating risk.

A few notes and assumptions: The data does not include inflation, which averages around 2% per year. However, the data also does not included dividends, which also averages around 2% per year. Therefore, I just assume they cancel each other out and don’t worry about either.

1. The first thing I notice is how stable the Average line is. Except for a small turn up in the 1 Year time horizon, the average line is basically flat. Across this time period (1950 to today), the average of the averages is 7.25%, with the 30-year average at 7.4%. Yes, this is slightly lower than the “8%” touted around the financial world, but it is pretty darn close. If you want to be conservative, use 7% as your expected return.


2. Risk in investing terms is measured by how volatile your investments are. It is extremely clear here how risky (volatile) stocks can really be in the short term. The worst 1-year period returned -45% (Feb 2008 to Feb 2009), while the best 1-year return was nearly 53% (June 1982 to June 1983). That’s a range of nearly 100%! It’s clear here that, even though you can expect a return of 8% for 1 year investment, you can do significantly better or significantly worse.


3. While the 1-year returns can be extremely volatile, it doesn’t take long for the range of returns to tighten around the average. The 15-year mark is important here, because it marks the first time horizon where the stock market has never lost money. In every 15-year time horizon since 1950, through all the ups and downs, you would have at least made your money back. This was truly surprising to me when I first saw it. I even checked the period ending February 2009 to double check (the 15-year return to that point was 3.1%). This just highlights why investors should focus on the long-term when making investment choices and not react to the day-to-day movements of the market.


4. At 20 years, the worst stock market period averaged 2.4%, which is about what a US government treasury bond is yielding today. If history is any guide, if your investment horizon is at least 20 years, you are nearly guaranteed to earn more in the stock market than you would in risk-free, US government bonds. The average return for the 20-year period is 7.1%, while the best 20-year period returned over 14%!


5. The 30 year time horizon is important to note for a couple of reasons. First, from a statistical standpoint, 30 is nearly infinity when you’re calculating things like present value, annuities, etc. Gong beyond 30 years doesn’t tell you much of anything. Whether you’re retiring at 35 or 65, your numbers will look pretty much the same after 30 years. Second, the bands of historical returns at 30 years is amazingly tight. The worst 30-year period since 1950 was 4.9%! That is an amazingly high number and represents very little risk when comparing it to the expected returns of other asset classes.


Note: While history is no guarantee of the future, I believe it can give a pretty good idea of what you can expect going forward.


Was there anything about this that surprised you? Would love to hear your thoughts!

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