The time of your life?

It’s interesting that I drafted this post 3 or 4 weeks ago, just before the current wave of stock market crashes hit us; now, of course, I am ‘preaching to the converted’

We spoke about getting – or beating – average returns from either stocks or real-estate, but David points out: what is an average financial return?

I agree with you about the number. However, think you should use real rates of returns not some theoretical possibility. For example your number on mutual funds is 9.5%. Well actual rates of returns for individuals investing in mutual funds averaged 4.4% over the last 20 years (Dalbar, Inc. Vanguard, etc.).

So, what are the average returns for the stock market?

First, define the ‘stock market’:

Do you mean the US market? International (if so, which country or countries)?

If US, do you mean large cap (the stocks with the largest total stock market value or ‘capitalization’)? Or, small cap? Or, do you mean stocks listed one one of the alternative exchanges such as NASDAQ?

Or, do you simply mean ‘all’ stocks listed on the New York stock exchange (NY Composite), or ‘only’ 5,000 stocks (Wilshire 5000) or perhaps ‘just’ 2,000 of the listed stocks (Russell 2000)?

If ‘large cap’ do you mean the top 500 stocks listed on the NY stock exchange (S&P 500) or perhaps the just the largest 30 (DJIA)?

The point here being that there is no such thing as an ‘average return for the stock market’ … you have to decide how you want to slice ‘n dice it first!

Semantics aside, let’s pick an Index – say, the S&P 500 – how has it performed?

Pick a Number!

Here is data taken from and summarized here into the average returns of the S&P 500 for various 10 years periods from 1989 – 1998 through to 1998 – 2007:

10 years too short?

OK, let’s find an online calculator and see how the S&P 500 performs over various 25 year periods:

In case you can’t read the diagram:

The best 25 year return (since 1871) for the S&P 500 was 17.6%, but the worst was 3.1% .. yah think that might make a difference if you your whole damn retirement strategy was hinging on achieving ‘average’ returns?!

BTW: If, you were ‘lucky’ enough to get the average, it was 9.4% …

… but, here’s the problem:

In ‘real life’ people don’t get the average!

Firstly, they rarely choose the S&P 500 … they usually gamble on just one or just a few Mutual Funds that used to perform better than the market (but, rarely ever do again).

Secondly, they pay fees that knock down returns by an average of 1.5%.

Thirdly, even if they do buy into a low cost Index Fund that tracks (say) the S&P 500, they actually rarely stay the course for the full 25 years (take another look at even the 10 year chart, above, if you want to see what that can do to the reliability of your returns).

Don’t believe me?

Check out the Dalbar Study

… then, scroll all the way back to the graph at the very top of this post:

Pictures really do tell more than a 1,000 words 🙂

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14 thoughts on “The time of your life?

  1. “In ‘real life’ people don’t get the average!”

    But savvy investors can! …when they buy low cost index funds and hold them for the long term.

  2. @ Jeff: You are right; in ‘real life’ investors get LESS than the average, but by buying a low cost index fund and BUYING/HOLDING THEM through thick and thin (right now, we are seeing money pouring OUT of these funds), gets you to within 0.2% of the AVERAGE.

    Even so, is ‘average’ something to aspire to? I guess if you’re defeatist, it’s better than the alternative …

  3. @AJC,

    “Even so, is ‘average’ something to aspire to? I guess if you’re defeatist, it’s better than the alternative …”

    Since, as shown in your graph above, index funds beat the “average” investor by 8% (compounded) return–not a trivial difference–proper investment in index funds allows you to aspire for a lot more than just being average. Further, when you look into the Dalbar study, index investing (over the 20 years that they covered) would give you 16% (compounded) return over market timing.

    The question I thought you’d come back with is: Will this approach get you to your number (by your date)? But I guess you assumed it didn’t provide adequate return…

    Personally, I think, at the very least, index investing would be a good part of a sound money 301 strategy.

  4. @ Jeff – “Average returns” not “average investor” … and, you are right” “Will this approach get you to your number (by your date)?” is exactly what I mean:

    3.9% – Average Investor Return

    11.9% – Average Market Return

    15% – 50%+ – Required to reach your Number/Date (for most).

    Thanks for helping to point out the (key) differences! AJC.

  5. @Jeff,
    You point out that discipline investing “through and thin” allows you to get the market return. This is another example of Wall Street propaganda. Very few people go through their lives without some common life events causing them to forego their monthly mutual fund deposit. Job losses, sickness, taking care of sick parents, divorce, etc. all cause folks to not only forego that mutual fund payment but many times having to sell some of their retirement funds for every day cash. The lie of the system is that people in this environment can save their way through all these common life events. Reams of data point out this lie. The bottom line is that any financial system that requires folks to make monthly inputs for 35 years is bound to fail.

    Add on to this the assumption of even returns from those silly retirement calculators and you see why we have a retirment crisis. Imagine if you were one of the lucky ones and successfully saved $1M in order to retire last year. You either have moved your savings to fixed interest accounts which means you forego rate of return for safety or you left it in equity mutual funds which means it is now worth $600,000. Either way you are in trouble with on average 20 years left to live and inflation eating away at you!

    Now if you were going to move your investments to fixed income or bonds and you started doing it 10 years before your retirement, reducing your overall rate of return. What does that do to your number?

    Its not that mutual funds are bad, its just that they don’t accomplish what they proport to accomplish, which is produce a comfortable retirement!

    And by the way, most people are forced into investing in mutual funds inside their 401Ks, which have on average a 3% cost. And then of course income tax is paid on it when you pull it out.

    Being an employee has never been so costly to the masses of people. Everything in our society is now organized to favor the investor/business owner. And neither candidate for President is going to change that!

  6. @ Shafer – The biggest issue that I see is that one must be in the market for 30 years in order to ‘guarantee’ at least an 8% return from the stock market. But, people contribute the bulk of their money in the middle-to-latter parts of that period (as salaries – hence, contributions – rise) so, they are getting less than 15 years return, which may not be sufficient time in the market to weather a storm such as we are currently seeing.

  7. @Shafer Financial –

    “You point out that discipline investing “through and thin” allows you to get the market return. This is another example of Wall Street propaganda.”

    This is not propaganda…when you buy a low cost index mutual fund you will get (near) market returns for as long as you hold that mutual fund–whether that holding period be 1 day, 1 year, or 30 years.

    That the average investor has a behaviorial flaw that causes them to sell low, does not obviate the fact that low cost index mutual funds provide (near) market returns. I believe that with education investor behavior can be modified, drasitically increasing the return to the average investor.

    I agree that sometimes life happens and that it can force people to sell early (assuming they didn’t plan ahead and have a proper emergency fund or safety net). This phenomena, however, is not strictly limited to mutual fund investing…nor does it disproportionately affect mutual fund investors.

    @AJC –
    Your point is a good one. When investing, your expected holding period often dictates your expected variance in outcome. As you get closer to retirement wihtout a significant nest egg, your expected time horizon shortens, increasing the range of expected outcomes. This, however, is not personal to mutual fund investing…

    Of course, if you already have a nest egg that can take you 10 or so years into retirement, your time horizon for new contributions increases by those 10 or so years.

  8. I love it when people blame a behavior flaw for bad returns. There is no aggregrate “behavior flaw” only behavior.

    What you are really saying is that *I* am so much smarter than everyone else investing in mutual funds, that *I* can make this strategy produce wealth where others have failed. One definition of insanity is doing the same thing again and again expecting different results to appear down the line.

    In all the literature/research I have found there is not one account of someone who worked as an employee/bought mutual funds monthly/and produced real wealth. I’m not saying there is no single person who did it that way, only if there was a even a small amount of folks who produced wealth that way we would see them appear in the research.

    But what we do see in the research is terrible rates of returns from folks who invest in mutual funds. This is the key takaway from what I so unartfully described in my previous post!

    But perhaps the basis of my issue with mutual funds is the fact you are in essense becoming a passive investor. If you are not willing to take the time and effort necessary to become an an active investor (stocks, real estate, options, whatever) then I don’t really think you have much of a chance to acquire real wealth. It might sound easy (just throw a few dollars monthly at a low cost mutual fund), but my experience is that what sounds easy, requires little effort, and minimizes relationships rarely is going to move someone to the head of the pack. And that is where AJC and I are moving people to!

  9. @ Jeff – I think the ‘argument’ – if there is one, as I believe that all three (you, me, shafer) are all pretty much saying the same thing – goes thus:

    1. By Definition, Index Funds (plus insignificant fees) = ‘the market’

    2. Over long periods – i.e. X years – the market (hence, ‘index funds) tend to produce Y% returns

    3. An investor makes a return V*Y where V is a measure of investor discipline; it would be tempting to think that V could range b/w 0 and 1 but, this is not necessarily the case.

    4. If an investor is highly disciplined, V = 1 (approx.) and the investor achieves market returns (approx.) for the selected period.

    5. But, the Dalbar study shows that the ‘average investor’ has a V of approx. 0.33 …. ooops!

    6. So, to achieve ‘market returns’ over long periods, an investor need not be concerned with investment choice: simply buy an appropriate Index Fund and concentrate on moving their V as close to 1 as humanly possible!

    7. However, we have a problem if we cannot raise V above 1: our return is equally LIMITED to the market return available.

    8. If this is sufficient to satisfy our financial needs through retirement stop HERE.

    9. If not, we need to either somehow raise our V > 1; Timing could achieve this … trade in/out of the Index on down/up swings OR

    9. We need to increase our return (i.e. ‘market returns’ are no longer sufficient); any of Shafer’s suggestion s (“become an an active investor (stocks, real estate, options, whatever”) could achieve this.

    If this makes sense, I’ll rework this into a post. What do you think?

  10. @AJC –

    Nice wrap up. Your analysis is correct, but #5 compares apples to oranges, IMO. It is impossible to draw conclusions from the Dalbar study about how investor discipline affects Index fund return.

    I would bet the difference in return is probably more influenced by the type of mutual fund purchased, fees, and loads, than discipline of the investor. For instance, if Dalbar’s mutual fund investors purchased balanced funds, bonds funds, and/or money market funds, you would expect lower returns (as they include underlying assets with inherently lower long term returns than the SP500) even if they were perfectly disciplined. The same goes for mutual funds that track different markets, sectors, regions, or countries, as they could have different long term expected returns than the SP500 (or deviant returns during the study period)–skewing the results up or down.

    I’m out after #6, as my comments were just meant to point out that, if you are going to invest in mutual funds, index funds are probably your best bet.

  11. @AJC –

    Not to further belabor the point (because I really don’t care that much anymore), but after reading this updated version of the study I still have the same questions regarding the difference between index fund return and the “average equity investor” in the Dalbar study. It seems that there are still three main factors that make up the difference: 1) investor discipline, 2) fees, and 3) fund type (although it doesn’t appear to include bond funds or money market funds–which is good). The study (as you point out) broadly concluding that investor behavior making up a larger portion of the difference than fund type.

    From the updated Dalbar study, it is still impossible to determine what proportion of the difference each of these 3 factors make up. But one thing we know for sure is that the entire difference is not due to investor behavior as #5 assumes.

    I’m sure if we cared to delve deeper into this study we could get an accurate picture of the “equity funds” the average investor purchased and the toll fees play…but my guess is that the point of your last comment (and possibly reworked post) was to show equity investing, even if performed with absolute perfect discipline and low fees, won’t get most of your readers to their number by their date.

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