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When there is a period of extreme market volatility, new investors may wonder whether it is really worth keeping their money in the stock market.
This was especially true in the first half of 2022, when stocks entered a bear market after the Federal Reserve began tightening monetary policy.
Throw away the doubt. In the long run, stocks are a worthwhile investment for most people, with one caveat: be prepared for the inevitable speed bumps along the way.
Don’t believe us? Consider the following data on average stock market returns.
Average stock market return for the S&P 500
The average return in the stock market depends on the time period you are measuring and the index used to represent the US market.
The index of choice in most cases is the S&P 500. It’s a useful proxy, but it’s only been around since 1957. Fortunately, you can use data from Nobel Prize-winning economist Robert Shiller to approximate the S&P 500.
Based on Shiller’s data, the S&P 500 has posted an annualized return of 7.58% since 1971, or 10.51% with dividends reinvested.
Investors who keep their money working in the S&P 500 have enjoyed long-term equity returns of about 10%.
That doesn’t mean you can expect a 10% return every year. Some years stocks have risen, while in others they fall. An annualized return is just an average earned over a period of time.
How long does it take for an investment to double in value?
How quickly an investment doubles depends on the return. To illustrate the point, let’s say you put $10,000 into an S&P 500 index fund. How long do you have to wait for it to turn into $20,000?
A general rule of thumb, the rule of 72, states that you can know how long it will take for your investment to double by dividing 72 by the return.
A 10% annual return means your money should double every 7.2 years. This can be a powerful investment insight, a true-to-life version of the folktale “grain of rice.”
According to the “double every seven years” model, if you had put $10,000 into an investment with a 10% annual return in the year 1995, you would have had about $20,000 in 2002, $40,000 in 2009, and $80,000 in 2016. You would also be looking at $160,000 next year — without adding another dollar.
Historically, how long has it taken for an equity investment to double?
NYU business professor Aswath Damodaran did the math. By his calculations, investment in the S&P 500 has doubled tenfold since 1949, or an average of about seven years at a time.
In some cases, such as from 1952 to 1955 or from 1995 to 1998, the value of the investment doubled in just three years. In other cases, investors had to be much more patient. For example, in 1928, investors had to wait until 1950 for their portfolios to double.
A word of warning: these calculations do not include transaction costs, which can reduce returns. Historical data does not exactly match the price of a stock that a trade in the past could have bought on any given trading day. Rather, they are an average closing price for a month. As such, there has been some rounding.
Can you lose money in stocks?
Take a relatively recent example from Damodaran’s data: Remember $100 invested in 1928? By 1999, that investment had risen to just over $155,000. However, a decade later, that same investment dropped to about $142,000, even with dividends reinvested.
Thanks to the dotcom crash and the Great Recession, the 2000s was essentially a lost decade for investors.
All cases of decline were not as dramatic as that terrible decade.
In the 94 years covered by Damodaran’s data, there were 25 years in which the value of S&P 500 investments fell. That’s about a 1 in 4 chance of losing money in stocks in any given year.
In 19 of those years, the loss was more than 5%.
On the plus side, there are many winning streaks. Long-term investors should have an annualized return of 10%.
Returns were over 10% in nearly 60% of the years covered in Damodaran’s data. That’s better than a 1 in 2 chance of double-digit gains during any given year.
How much can you earn with stocks?
There’s a reason financial advisors want so much of your wealth tied up in the future cash flows of publicly traded companies.
Damodaran found that $100 invested in 1928 would have been worth it:
- $1,000 by the mid-1950s.
- $10,000 by the mid-1980s.
- $100,000 by the turn of the century.
- Nearly $750,000 by the end of 2021.
In very rough terms, $100 turned into about $1 million in 100 years.
That same $100 invested in:
- USTreasury bonds would yield about $8,500.
- Corporate bonds would bring in about $55,000.
- Real estate would bring in $5,000.
If you have the time to get through years of losses, there’s no better long-term investment than a well-diversified portfolio of high-quality stocks.
What is your investment time horizon?
So long-term investing is powerful, which should calm your nerves when hard times come. But it is important to understand what is meant by ‘long term’.
Unfortunately, many people think it means a year or two. Not true.
If you want to feel good about expecting a 10% market return, you need to think in decades rather than years. But don’t be discouraged. Your downside risk is a decade or so of smaller returns, and your upside doubling every four or five years.
However, there are very bad market years. No one who needs money for the next five years should have that money invested aggressively in the stock market. People in their 60s and maybe even 50s should start thinking about withdrawing from such volatility.
For example, anyone who retired between 2000 and 2002, without doing so, found their retirement kitten reduced to a third and learned this painful lesson the hard way.
But if time is on your side, market swings like what we’re seeing now shouldn’t phase you.
We cannot promise when this volatility will end. The pandemic market shock came and went in a matter of months, and the bear market of the 1970s lasted for nearly two decades. But in the long run, you can expect your investments to grow at about 10% per year, doubling every seven years or so.