Wait, What’s the Real Average Stock Market Return?

What's the Real Stock Market Return - picture of stock market board

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Hey frugal fanatics! Welcome back.

So, something has really been stuck in my craw lately, and I can stay silent no longer! It’s about the average stock market return, and it’s time to drop a few truth bombs ’round here.

I know we don’t talk a ton about hardcore investing topics on this blog, but we do frequently discuss ways to save and make extra money. The fact is, if you want to do both, investing needs to be part of your plan. This is especially true if you ever want to retire.

There’s no denying that investing in the stock market is one of the best ways to make residual income. That being said, it’s important to know what you’re getting yourself into.

Understanding the basics about how the market works, comprehending common terms, and knowing what you’re buying are all crucial to having success. (Psst…this guide to investing for beginners can help!)

But, that’s not all there is to it.

One of the most misunderstood investing concepts is the idea of the annual “average stock market return.” While financial advisors are quick to throw this stat around to encourage investment (and stimulate sales), this metric isn’t the most reliable way to measure your returns. And if you don’t understand it, you might be left wondering why your investments are underperforming.

Frugal fans rejoice! I’m here to clear things up for you.

Whether you’re a new investor or someone who’s already saving for retirement, I’ll help you understand what the average annual stock market return is, why it’s “wrong,” and what you should use to gauge your investments instead. If you’re ready, let’s dive in.

Why You Shouldn’t Expect an Average Stock Market Return of 10%

What if I told you that the “real” average stock market return since 1900 is actually 6.53% per year? You’d probably call me a liar, right?

Well, it’s true.

“Wait, my financial advisor told me that it was over 10%!”

Technically, they’re not wrong. The average return of the S&P 500 over that time period (including dividends) is 11.53%.

But, while true, that statistic is totally misleading. Salespeople are quoting it because it suits their agenda and makes the gains look better than they are.

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Average Stock Market Return Examples

So, why shouldn’t you rely on the average annual return metric? Let’s take a look at how average returns are calculated.

To calculate an average annual stock market return over a period of time, take the percentage your investment gained/lost each year and divide it by the number of total years you are considering. Here’s the formula:

Sum of % Gain or Loss / Total Number of Years = Average Annual Return

Example 1: Let’s assume that you invest $1,000. The first year, your money grows by 100%, so you’ve now got $2,000. Pretty great, right? But, in year number 2, it loses 50% of its value. You’re back to the original $1,000…but your average annual return equals 25%. So why is your average return 25% even though you didn’t make any money? Using our formula, here’s the answer:

100% + -50% / 2 years = 25% average annual return

Of course, you know you haven’t made any money; but, if you don’t know how to figure a “true” average annual return, you could easily be convinced otherwise.

Example 2: It’s even worse if you lose money. Suppose you lose 25% the first year. You’d now have $750. If you gained 25% the next year, your average annual return equals 0%. But you’re not back to even. Nope. In reality, you only have $937.50 ($750 x 25% = $937.50). Yikes.

More Reasons Average Returns are Misleading

This isn’t the only reason using average returns is misleading. If you expect a smooth 10% gain year after year, you’re in for a rude awakening.

Unfortunately, the market doesn’t play that game. It can be extremely volatile, especially over the short term. When you look at annual returns for the S&P 500 from 1950 to 2015 (65 years), annual returns have only reached the average 37 times. In fact, it’s actually produced a negative return 15 of those years. That’s a pretty bumpy ride.

You also need to realize that when somebody quotes the average stock market return of 10-12% per year, they’re including dividends but not adjusting for inflation. When you adjust for inflation, the average annual return since 1900 drops even lower, sitting at 8.41%.

See Also: The Best FREE Money Tools You’ll Ever Use

How to Calculate the “Real” Average Stock Market Return

You’re probably saying, “There’s got to be a better way to measure my returns over time!”

There is. It’s called the Compound Annual Growth Rate, or CAGR for short.

CAGR is a much more accurate measurement because it accounts for “annualized” growth. Because of that, it fills in the real picture in areas where the average stock market return statistic falls short.

If we head back to “Example 1,”the average return would read 25% while the CAGR would equal 0%. In Example 2, you’d show a 0% average return while the CAGR would equal -3.18%.

Clearly, CAGR does a better job of reflecting your true average of your returns over time. Since the formula for CAGR is fairly complex, I recommend using a good CAGR calculator to figure it out.

CAGR vs. Average Annual Stock Market Returns

So, what is the “real” average stock market return since 1900?

If you’re using a strict average annual return that includes dividends, the average stock market return is 11.53%. When adjusted for inflation, that number drops to 8.41%. But now you know that doesn’t give you the true picture.

When we look at CAGR, we see that the S&P 500 produced a return of 9.70% a year from 1900 to 2015 (including dividends). Adjusted for inflation, the value in today’s dollars drops to 6.53%.

Basically, since 1900, the amount of money you have now grew in value by an average of 6.53% a year when measured in the worth of today’s dollar….and that doesn’t even include the fees you may have paid. Add those in, and that’s what I’d consider the “real” average return on your money.

The Verdict

Instead of looking at the average stock market return, use the CAGR to get the best idea of how well your investments are performing. And the next time somebody tells you the average stock market return is around 10 to 12%, just shake your head and realize you’re being sold.

While the statistic isn’t a lie, it isn’t quite true either. As with all things in sales, scratch a little below the surface and you’ll probably find the true story.

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  1. Love this last line Greg – “scratch a little below the surface and you’ll probably find the true story” and it is so true! People seem to be so busy that headlines and things like “averages” sway their ideas about reality. Thanks for the clear breakdown here. A few minutes of digging deeper can reveal a whole lot.

    1. Thanks Vicki! It doesn’t take too much digging to usually find the truth…and don’t get me going on the headline media these days 😉

  2. It’s extremely difficult to compare any return against any other return, like you say Greg.

    Those figures you quote are also the gross returns, when the most important number people need to be thinking about is the net return (when you take off fees).

    The start point of the return is also hugely significant. If I invest in a Vanguard fund today, my actual return to the year end will be different to the return Vanguard quotes the fund to receive for the year (from 1st January to 31st December). The fund might even have lost money during the year, and I could have bought at a lower price and made a gain!

    You can extend the comparison game to all other investments. If a property was $200k and then goes up to $250k – people would say that’s 25% gain. But that doesn’t include all the buying costs (lawyers, taxes, agents fees) and selling costs (lawyers, taxes, agents fees). We don’t make as much money as we think!


    1. You are absolutely right, we don’t make as much money as we think. We’re sold on the concept that we do, but when you add in fees/taxes/etc., it’s often much less than expected.

      As I’ve gotten older, one thing I’ve realized is that you can twist numbers to make them say whatever you want. We think that numbers are these concrete statistics that only show the truth, but they are much more malleable than most people realize.

  3. Whenever people post large averages (I’m looking at you, Dave Ramsey), it makes my blood run cold. As someone who got in the market at just the wrong time, I’ve been burned enough and seen enough red to know that 12% is unreasonable. Would I love it? Absolutely. Would I be beyond heartbroken if that’s what my expectation was when I started investing? Uhhhh, YES!

    1. Yep. If you’re expecting double digit returns but only realize a true return of 7% after taxes and fees (and adjusted for inflation), of course you’d be disappointed. In reality, you probably did pretty well.

  4. Nice breakdown Greg! I recently had a conversation with a family member as I’m helping them start investing and discussed this topic in particular. Reality is much different from headlines, on a good day, so it’s important to be able to know how to do the math yourself.

    1. Everybody loves a good headline, but headlines are meant to sell. If you don’t go into it with your eyes wide open, you could be very disappointed by some pretty good results.

  5. The sad part is people are running the numbers based on the hope they will get 12%, and by the time they hit their 40-50’s they might find they have come up woefully short. I have met people who tell me, “I used an online calculator 4 years ago and it said I need to save $350 a month, so that is what I do.” I would rather be save a bit more on the front end than come up short on the back end. Worst case, we retire early. Oh darn. =)

    1. I totally agree with you. When it comes to projections, I always try to err on the conservative side. I would much rather have more than I need in retirement than run out of money.

  6. Thanks for writing this post, Greg! It pains me to think of all of the people who have been led to believe they will get those unbelievably high returns and then get skunked. I was really happy to see the 6.53% return figure, as I always use 6% as an assumption when projecting future investment $.

    1. I usually use 6% when I figure projections through a calculator as well. I also adjust it for inflation (when I have the option). Using 6% seems relatively safe and helps account for fees as well.

    1. Thank you very much! I appreciate that 🙂 I hope the piece helps someone out there!

  7. This is very enlightening. You opened up a great point that hopefully everyone remembers when listening to investment people.
    I always use an average of 6% as well when projecting any possible earnings too.

  8. LeRainDrop says:

    Great explanation, Greg. It’s also really important for investors to understand that not all brokerages and funds are created equally — the FEES have a HUGE impact on your investment value over time. Here’s a good bulletin from the SEC: https://www.sec.gov/investor/alerts/ib_fees_expenses.pdf

  9. Thanks for the simple explanation! I must admit I’m totally intimidated by the stock market, but am aware that I need to learn. For now, I have an adviser I trust, but at the end of the day, I’d feel better if I understood it all myself.

  10. We use CAGR all the time in corporate finance, but I haven’t heard anyone talk about it in terms of personal finance. Makes a lot of sense.

  11. Thank you for your post. I disagree on one point. You’re looking at the CAGR of 115 years. If you look at the CAGR instead for every possible 30 or 40 year period many of the period have a much higher CAGR than 9.70%. There definitely is luck involved in which year you enter and leave the market. Don’t give up hope folks.

  12. For my own studies, may I know which prices you used in your CAGR calculations for the S&P? (ie ending and beginning balance)

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