When I talk about stock investment, I normally say that you can expect to earn a 7% yearly return on average.This figure is based on a couple of assumptions.
First, I’m presuming you’re planning to invest for more than ten years.
This is due to the fact that the stock market is quite volatile over the course of a year.
The stock market takes a huge hit every now and then, such as in 2008, when many stocks lost 40% of their value.Other years have seen far higher growth than 7%.
It’s only over a longer length of time that you start to approach that consistent 7% average.
Second, I’m presuming you’re investing in a broad-based index, such as the Vanguard Total Stock Market Index.If you’re only investing in the stocks of one or a few companies, that 7% return isn’t applicable.
That type of investment is simply too risky.
But where did the figure of 7% come from?
Warren Buffett, who asserts categorically that you should expect a 6-7 percent yearly return in the stock market over the long term, is my primary source for that figure.Buffett recounts the analysis that brought him to that conclusion in that article:
“The economy, as defined by gross domestic product, can be projected to grow at an annual pace of around 3% over the long run,” Buffett said, adding that inflation of 2% would push nominal GDP growth to 5%. Stocks are expected to climb at a similar rate, with dividend payments boosting overall returns to 6% to 7%, he said.”
Isn’t the stock market supposed to do better than that?
“From 1982 to 1999, the Standard & Poor’s 500 Index, a benchmark for U.S. stocks, increased by 18 percent every year on average.According to Buffett, the bull market poisoned investor expectations.
According to polls conducted in the late 1990s, some investors expected equities to gain 14 percent to 15 percent per year.
“‘Doing that in a low-inflation climate is a pipe dream,’ he said.”
Aside from that, the stock market’s long-term data also speaks to that 7% figure.
If you adjust the S&P 500 for inflation and dividends from 1950 to 2009, you get an average annual return of exactly 7.0 percent. Examine the information for yourself.
I’m ready to use 7% as an estimate of long-term stock market returns based on these two factors: raw historical data and Warren Buffett’s research.
There is, however, one major issue. Past success is no guarantee of future outcomes. Any investment is true of that basic assertion. It applies to practically everything in life.
We have no way of knowing what the future holds.
Some predict that the second half of this decade will see an economic resurgence in the United States, thanks to our growing energy independence and a long era of low-interest loans that have fueled rapid corporate expansion. Others believe that our economic future is doomed.
Nothing is certain. We can only do our best to place ourselves in the best possible situation.
Diversification is important to me, and part of that diversification comes in the shape of long-term index funds.