Investors question wisdom of 10% rate of return rule
— -- Q: People often talk about stocks returning 10% a year, but that's based on a very long-term track record. How have stocks done during shorter periods of time?
A: The rule of thumb that stocks return 10% a year was gospel. Now it's considered heresy.
Investors, frustrated by a decade of poor returns by stocks, are questioning everything. Proven techniques of diversification and long-term investors are under assault. And included in the hit list of stock market assumptions is the long-term stock market data showing that stocks, on average, return 10% a year.
You're right. The oft-quoted statistic of 10% a year returns is based on nearly 100 years of stock market data. To be precise, large-cap U.S. stocks have, on average, generated a compound average rate of growth of 9.3% since 1928, says IFA.com. Thanks to the abysmal past five years for stocks, that number was dragged down to 9.3% from its more traditional 10%.
Some investors get annoyed when people quote the 9.3% number because it's based on such a long-term track record. The reason behind doing this, though, is based on statistics. Statistical analysis, in order to be valid, requires the use of a large sample size. Statistics based on just a few years of data don't tell you much. You need to study at least 30 or more years of data to get a good statistical average.
But you ask a valid question. How have stocks actually done over the past, during shorter periods of time? Below is data showing the total return of large stocks per year over the past five, 10, 20, 30, 40 and 50 years, according to IFA.com:
• 5 years: 1.3%
• 10 years: 2.0%
• 20 years: 7.9%
• 30 years: 10.5%
• 40 years: 9.8%
• 50 years: 9.2%
As you can see, over time the returns get very close to the long-term average annual return of the stock market. In fact, if there's an anomaly, it's the very poor performance over the past five and ten years.
Your question gets to the crux of the difficulty in using past results to predict future returns. If you measure your portfolio in the middle of a deep correction, you're likely to be disappointed by what you see. However, if you measure during normal times, you'll most likely get a number very close to the market's long-term returns.
Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Follow Matt on Twitter at: twitter.com/mattkrantz
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