There seems to be no agreement on how much the stock market returns on average each year. Some say 8%, I’ve seen others say 7%. There are conservative numbers like 6% or high expectations such as 10%. I personally would use 8% as the number I expect the market to return each year. But not anymore.
Over the last ten years, the S&P 500 has provided an annual return of 11.56%. There is reason to believe this annual 11.56% average can continue for the foreseeable future.
The Numbers
I went through Yahoo Finance and found the closing price of the S&P 500 for the last trading day of the year, for every year, from 2010 to 2020. That is 11 data points, one for each year. Using a simple formula in Excel, I found the CAGR (Compound Annual Growth Rate) of the investment. The S&P 500 had returned 11.56% year over year growth for the ten year period.
I also provided the return from one year to the next. So in 2020 the S&P 500 returned 16.26%, in 2019 it returned 28.88%, etc.
2010 and 2011 are not typos. They closed the year at almost identical prices. As you can see, most years the market was positive. And when it was positive, it was usually above the 11.56%.
Why This Can Continue
A return of 11.56% is above the normal mantra of expecting 8% a year. But it is also a smaller window of data. What it lacks in data size, it makes up for in relativity.
The economy and stock market are vastly different than what they were in 1950, or even 1990. The past decade is the closest representation of today’s market, and therefore the closest estimate we have for what to expect in terms of a return.
The federal funds rate has a big impact on the economy. For starters, it impacts the rate at which businesses borrow money. If the rate is low, businesses will take on more debt because it is cheaper, thus helping the economy expand and money flow. The biggest impact though, is that it touches all consumers and what they do with their money.
Banks rely on the federal funds rate to determine the interest you get on your account. You may have noticed the interest you received in your savings account was a greater percentage before the pandemic than it is now. That is because the Federal Reserve slashed the federal funds rate to help the economy, and banks responded by lowering their interest rates.
The federal funds rate also impacts the yield investors receive on bonds — because the price to borrow money (for corporations or the US treasury) is lower than before, investors will get a lower yield from bonds.
What does this all mean for stocks though?
Investors face a choice of what to do with their money, an opportunity cost. Those looking to grow their wealth can no longer do so as easily by investing in safer assets like savings accounts and bonds. More and more people are investing in stocks so their money can grow; they want their money to work for them, not lose value due to inflation.
As the graph shows, the federal funds rate is at all-time lows. And was for most of the past decade as well. This is what helped cause the market to return 11.56% annually over the last ten years. Because people couldn’t get a good return on their money in savings accounts and bonds, they ventured into the stock market to get the return they desired.
Such is the case today. More and more people are investing in the stock market to get a decent return. Because more money is going into the market, prices are being elevated. At the end of the day, the stock market is a simple supply and demanded barter system. I want to buy this stock so I have to offer a price above the current value of the asset. The more people who want to buy, the more demand, the higher the price.
The market offered better returns this past decade than in the 80s when the federal funds rate was higher and saving accounts gave more interest.
As APNews reported, “The Federal Reserve expects to keep its benchmark short-term interest rate near zero through at least 2023.”
With the federal funds rate at a low level, and where it will probably stay for the foreseeable future, one can expect more money to go into the stock market. If more money moves into stocks, it is likely their prices will increase and help you get that 11.56% annual return on your investment.