Note from dshort: I received an email this morning pointing out that it's been a few months since I've updated my commentary on long-term total returns. So, for a Valentine's Day special, I've updated the charts below based on monthly data through the January 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 $11,071, a fairly mediocre annualized real return of 2.04%.
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.
The Fun Runs of the Roller Coaster
Let's increase the timeframe to 10 years. The total return has improved significantly. Your $10K has grown to a little over $16K adjusted for inflation, an annualized real return of 4.80%.
Now let's imagine that we time-travel back to September 2000 and pose the same question. Your ten-year inflation-adjusted gain from September 1990 would have been $49,638 — up 396% for an annualized real return of 16.13%. As the chart illustrates, investment performance with a 10-year timeline has been a real roller coaster as far back as we have data.
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 slightly 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 risk. Households approaching retirement should understand this risk and make rational decisions about diversification. In this 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. But this traditional wisdom has been less helpful than in the past 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 and Mike Philbrick, 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)