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Whether you are a novice investor or have been investing for years, evaluating investment returns can be challenging. Of course, most investors generally hope their portfolios will perform well and will provide positive returns. However, most investment professionals encourage their customers to avoid “chasing” returns and caution them against choosing investments based solely on how well they performed in the most recent month, quarter, or year. That's because past performance is not a guarantee of future results. So, a stock, bond, mutual fund, or other product that was at the top of the chart for performance last year could perform poorly this year, and vice versa.
Historical Stock Market Returns
While making decisions to buy or sell a specific investment based on returns alone is not generally prudent, it can be helpful to understand investment performance in the context of the market's returns as a whole by looking at index performance over time. Understand that indices are not available for direct investments. In addition, index returns do not reflect fees or expenses individual investors pay. Still, indices provide a window into how the underlying market is doing.
The S&P 500 index (Standard & Poor's index containing 500 large-cap equity stocks covering approximately 80% of available market capitalization) was introduced in its current form in 1957. This index has widely represented the overall stock market performance in the U.S. since 1968. Historically, this benchmark has returned approximately 10% per year. Returns can be volatile, however, so that average of 10% per year is sometimes significantly higher, and sometimes significantly lower.
For example, in 1974, the S&P's return was -29.72%, followed by 31.55% returns the following year1. More recently, the ten-year annualized return for the S&P 500 as of April 16, 2021 was 12.23%. That may sound attractive. But even that number includes several years of negative or “flat” returns (0.00% in 2011, 0.73% in 2015, and -6.24% in 20182.
Rule of 72
Although there are no guarantees about what the market will do in the future, there is a simple formula investors can use to estimate how long it will take their holdings to double in value, based on a fixed rate of return. The formula is straightforward: 72 divided by the expected rate of return = the number of years it would take your investment to double.
So, if your investment earned a 1% return, it would take 72 years to double. In contrast, an investment earning a 9% return would take 8 years to double.
Of course, as we can see from the S&P's performance over time, investments do not grow at a fixed rate. Nevertheless, the Rule of 72 can still be useful as a guide, providing an approximation of how quickly you might see growth in your portfolio.
The Low-Risk, Low-Return Investment Pitfall
If the idea of riding a roller coaster of investment returns sounds like it involves more risk than you are comfortable taking, there are many investments with lower risk profiles. In other words, certain types of investments may be considered “safer” options with less volatility. However, the tradeoff is that lower risk investments typically provide lower returns. While the risk of market loss is mitigated, low-risk/low-return investments come with the risk that your investments may not keep up with inflation.
Diversifying your portfolio by investing in different types of investments with different risk/return profiles may help investors keep pace with inflation, managing both investment risk and purchasing power risk. Talk to your investment professional to explore potential investment strategies that are aligned with your time horizon, risk profile, and goals.
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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
The information provided is not intended to be a substitute for specific individualized tax planning or legal advice. We suggest that you consult with a qualified tax or legal advisor.
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