Note from dshort: I received a recent email on historical total returns that prompted an update to my Roller Coaster Return series. I've updated the charts below based on monthly data through the September close.
Here's an interesting set of charts that will especially resonate with those of us who follow economic and market cycles.
Imagine that five years ago you invested $10,000 in the S&P 500. How much would it be worth today, with dividends reinvested but adjusted for inflation?
The purchasing power of your investment has increased to $19,967 for an annualized real return of 13.91%.
Had I posed the same question in March 2009, the answer would have been a depressing $5,521. The -5.93% real return would have cut the purchasing power of your initial investment nearly in half.
Fun Runs of the Roller Coaster
Let's increase the timeframe to 10 years. The annualized return is considerably smaller. Your $10K invested 10 years ago has grown to about $17.7K adjusted for inflation, an annualized real return of 5.74%.
The 15-year timeframe is quite disappointing. Your one-and-a-half decade investment of $10K has only grown to about 14.1K adjusted for inflation for a measly annualized real return of 2.32%.
If we extend our investment horizon to 20 years, the roller coaster is less volatile with higher lows and lower highs.
The volatility decreases further with a 30-year timeline. But even for that three-decade investment, the annualized returns since the 1901 have ranged from less than 2% to over 11%.
As these charts illustrate, and as many households have discovered during the 21st century so far, investing in equities carries substantial risk. Households approaching retirement should understand this risk and make rational decisions about diversification. In the past I've suggested that they should also consider fixed income alternatives for that part of the nest egg that will pay non-discretionary expenses not covered by Social Security and pensions. Unfortunately this traditional wisdom has been less helpful in recent years owing to the Fed Zero Interest Rate Policy (ZIRP) and various stimulus strategies, which have collectively shrunk interest rates.
You can play around with hypothetical returns — both nominal and real — over various time frames with this nifty The S&P 500 Calculator at the Political Calculations website. Here's another version that allows you to include a fixed monthly additional contribution.
See also the research of Adam Butler, Mike Philbrick and Rodrigo Gordillo, who have closely examined the subject of estimating future returns and explored various strategies to optimize investment performance:
- The Full Montier: Absolute vs. Relative Value
- Don't Take Our Word For It
- Tactical Alpha: The Case for Active Asset Allocation
- Equity Portfolio Optimization with Factor Tilts
- Permanent Portfolio Shakedown Part 1
- Permanent Portfolio Shakedown Part 2
- The Permanent Portfolio Turns Japanese
- Estimating Future Returns: New Update
- Retirement's Volatility Bogeyman
- 2277 Stocks and Still Not Diversified?
- How to Beat the Market, and Why Most Investors Don't
- Volatility Management for Better Absolute and Risk-Adjusted Performance
- Diversification: Still the Only Free Lunch
- Adaptive Asset Allocation: A True Revolution in Portfolio Management
- Adaptive Risk Parity for a Better 'Balanced Fund'
- Risk Parity: Past Its Prime
- Track Records are Rubbish (or Why Managers are Factors in Drag)
- Predicting Markets, or Marketing Predictions
- Balanced Portfolios: Keeping it Real
- Safe Withdrawal Rate Risks and the Implications for Asset Allocation
- Valuation Based Equity Market Forecasts - Q1 2013 Update
- What the Bull Giveth, the Bear Taketh Away
- The Whole is Greater than the Sum of the Parts
- Triumph of the Ostriches
- Dynamic Asset Allocation for Practitioners Part 1: The Many Faces of Momentum
- The Most Important Concept in Wealth Management
- Dynamic Asset Allocation for Practitioners Part 3: Momentum Weighting
- Path Dependency in Financial Planning: Savings Edition
- Valuation Based Equity Market Forecasts - Q2 2013 Update
- Planning for Adverse Scenarios: Savings Edition
- Structural Diversification for All Seasons
- Valuation Based Equity Market Forecasts: Q2 2014