THE 10% AVERAGE MARKET RETURN LIE
(AND WHAT IT MEANS TO INVESTORS)

Michael D. Reese, CFP®, CLU, ChFC

January 2009

THE 10% AVERAGE MARKET RETURN LIE,

AND WHAT IT MEANS TO INVESTORS

Talk to almost any financial advisor, and they will tell you that the stock market, “long-term”, averages a 10% rate of return. They love to point to the past 70 years, in an attempt to prove their case. If you ask them to define “long-term”, they will almost certainly say, “10 years or longer”.

And you know what? Over the last 70 years, the market has averaged a 10% return per year. But here’s my question. We have market data going back to 1896, so why are we using just part of the data and not all of it?

Once we start looking at all the data, the answer becomes very clear. All the data doesn’t support a 10% average return, and that is a message that big brokerage firms would prefer not to get out.

I like to get right answers, so here’s what I did. I downloaded the history of the Dow Jones Industrial Average since it started (or at least since we have data on it) in 1896. I got the data from Dow Jones itself at

Then, to keep it simple, I started calculating year-by-year returns and grouped them by decades. I started with 1900 – 1909, then went to 1910 – 1919, and so on. I started in 1900, because the data only went back to 1896, and I didn’t want to do 1896 – 1905, 1906 – 1915, etc. So my analysis does leave out the first few years.

What I Learned

Here’s what I learned about how the market performed over the decades, starting in 1900:

DecadeReturnReturn + 3% Dividend

1900 – 1909+4.19%+7.19%

1910 – 1919+0.80%+3.80%

1920 – 1929+8.77%+11.77%

1930 – 1939-4.92%-1.92%

1940 – 1949+2.95%+5.95%

1950 – 1959+12.98%+15.98%

1960 – 1969+1.65%+4.65%

1970 – 1979+0.47%+3.47%

1980 – 1989+12.62%+15.62%

1990 – 1999+15.37%+18.37%

2000 – 2008-2.96%+0.04%

Average Return+4.72%+7.72%

Now, please be aware of two items. First, dividends are NOT included. In the far right column, I plugged in the effect of a 3% dividend. But you need to recognize that this is only an estimate. Dividends vary throughout the years. They were a bit higher in the early years and lower in the more recent years. If you don’t like my 3% dividend rate, please feel free to plug in your own.

Second, the returns calculated are compound annual returns. That means that if at the beginning of each decade, you purchased a 10-year CD at the return rate of that decade, you would have exactly the same amount of money in your account. For example, let’s say that on January 1, 1900, you went to a bank and bought a 10-year CD paying you 7.19% per year of interest. You then took an equal amount of money and placed it into the Dow Jones Industrial Average and let’s assume that those companies were paying a 3% dividend for each of the next 10 years, and you reinvested those dividends. On December 31, 1909, you would have exactly the same amount of money in each account.

Analyzing The Data

If you take a look at the returns by decade, you start to notice some interesting results. Let’s use the “3% dividend” column for our discussion.

First, you’ll see that out of the eleven (11) decades represented (with 2000 – 2008 being one year short), only four (4) of them broke the classic 10% per year return. And when they did better, boy oh boy did they do better! For the most part, the good decades crushed the 10% average number.

But what about the other seven (7) decades? After all, aren’t they the majority? If you look at those decades, you find that you will normally fall far short of the 10% per year average. So what does this tell us?

The majority of the time (64%), the market returns far less than the touted “10%” average rate of return. Only 36% of the decades beat the 10% number (unless, of course, 2009 pulls off a 240% return). So over a 10 year period, you have roughly a 1/3 chance at beating a 10% return in the market, and a 2/3 chance of falling far short of your target.

Further, you’ll notice that long-term, the market actually averaged closer to 8% than 10% when you use all the data (minus the first few years, of course).

Finding Patterns

Do you see a pattern in the data? How about this? The market seems to have a tendency of low returns, or pretty flat returns, over a 20-year period. And then it takes off for a decade. What do I mean?

Look at 1900 – 1919. You see 20 years of lower returns. Then suddenly, the decade of the 1920’s goes crazy. Next, 1930 – 1949. 20 more years of lower returns. Then the 1950’s hit, and it’s boom time. Following is 1960 – 1979, more blah years. But then the pattern broke, and we had two good decades in a row, the 1980’s and the 1990’s. This was unprecedented growth. But what’s happened in the 2000’s? Back to more blah.

What Does The Future Bring?

The big question here is what will we see going forward? Will we see a return to big returns, or will we revert to the mean, and are we in the middle of a 20-year low return cycle? Nobody knows that answer, of course, but it’s also true that history has a way of repeating itself.

Of course, when it comes to your investments, where the markets are going is a huge deal. You need to have some kind of feel of market direction to position your holdings. Buy and hold works great when times are good, and the 1980’s and 1990’s were a good example of that. It doesn’t work so well, though, in the lower return years. During those time periods, your account balances look like a roller coaster. Basically, you see a bunch of ups and downs, but overall, you’re not really going anywhere.

Investment Options

When it comes down to it, you really only have three basic types of investments to choose from: fixed, market, and hybrid. Let’s describe each of them and discuss when they are most attractive.

Fixed investments are those that provide you a guaranteed rate of return and no market risk. Generally speaking you have three to choose from:

  1. CD’s
  2. Government Bonds
  3. Fixed Annuities

Each of these provide you a guaranteed rate of return, while protecting your principal at the same time. The disadvantage, of course, is that the returns are often relatively low.

Market investments are those that are linked to the stock market in some form. You may hold individual stocks, mutual funds, unit investment trusts, etc. With these investments, you are trading security for a potentially higher rate of return. You might hold these accounts at mutual fund companies, brokerage houses, or insurance companies.

Hybrid investments are a creation of insurance companies, and they pay you an interest rate equal to some calculation of what a market index does. For example, you might receive interest for the year equal to 50% of what the Dow Jones Industrial Average does. If the index goes down for the year, you simply receive 0% interest. You do not lose anything.

So with hybrid investments, your annual return might vary from 0% to 20% depending on what the index your interest is linked to does. So these accounts are a way for you to participate in market returns in years that the market does well without the risk.

What Investment to Use When

Now, when does each investment option perform well, and when should they be avoided? A simple matrix below tells the story.

Market Direction / Best / Next / Worst
Market Going Up / Market / Hybrid / Fixed
Market Going Down / Fixed / Hybrid / Market
Market Up & Down / Hybrid / Fixed* / Market*

*Note: in decades when the market is going up & down, when all is said and done, the fixed and market positions might flip, depending on the final market results. However, even if the market ekes out a bit better return than fixed for the period, very few people find the additional return worth the risk they had to take to get it. In other words, over a 10-year period, market investments might have earned 1% per year more, but you had significant up & down movements along the way.

I’m often asked why hybrids do better in up & down market conditions than the other options. The reason is pretty simple – hybrids are credited with significant interest when the market is up, yet they lose nothing when the market is down.

Comparing Market Investments vs. Hybrid Investments

Here’s an example of a 10-year up & down period, 1970 – 1979.

Year / Dow Return / Plus 3% Div / Growth of $100K / 50% Hybrid / Growth of $100K
1970 / 4.82% / 7.82% / $107,818 / 2.41% / $102,409
1971 / 6.11% / 9.11% / $117,643 / 3.05% / $105,539
1972 / 14.58% / 17.58% / $138,328 / 7.29% / $113,234
1973 / -16.58% / -13.58% / $119,538 / 0% / $113,234
1974 / -27.57% / -24.57% / $90,162 / 0% / $113,234
1975 / 38.32% / 41.32% / $127,421 / 19.16% / $134,933
1976 / 17.86% / 20.86% / $154,001 / 8.93% / $146,982
1977 / -17.27% / -14.27% / $132,028 / 0% / $146,982
1978 / -3.15% / -0.15% / $131,834 / 0% / $146,982
1979 / 4.19% / 7.19% / $141,313 / 2.09% / $150,061

Since some people understand better with pictures (I’m one of them), I’ve graphed out on the next page what the portfolio values would be if one invested in the market directly during this time period vs. investing in a hybrid approach that credits interest at an amount equal to 50% of the Dow Return, not including dividends.

From the chart, you see the value of avoiding the negative market years. When it comes to investing, the good years help, but the bad years kill you. When faced with a constantly rising market, like we saw in the 1950’s, 1980’s, and 1990’s, being in the market directly is a sure winner. The problem is that only helps you about 1/3 of the decades. The majority of the decades, you get something very similar to the above chart.

Here’s another chart that’s a bit more recent.

Summary

When you invest in the stock market, you are told that it is reasonable to expect a 10% average return, because “that’s what the market averages over time”. The problem is that 10 years is clearly not enough time to have any reasonable expectation of hitting that average. In fact, 20 years is also not long enough. As a result, millions of Americans may end up going through their entire retirement years, never reaching their investment expectations.

The culprit in the underperforming decades is that they have a few negative years. It’s not that the markets are down every year during those decades, just a few. And it only takes one or two down years to kill the return of an entire decade.

Fortunately, other avenues are available, including fixed and hybrid investments, to assist an investor in protecting against those very downturns that kill you. Since you can anticipate these types of downturns every 2 out of 3 decades, you would be wise to consider other options to immunize your retirement portfolio against significant risk.

Michael Reese, CFP®, CLU, ChFC is the founder and principal of Centennial Wealth Advisory based in Traverse City, MI. He is a Certified Financial Planner™, Chartered Financial Consultant, and a Chartered Life Underwriter. He has been cited in numerous industry publications for his expertise on retirement planning, including “US News & World Reports”.

Mr. Reese specializes in creating innovative tax and investment solutions to help his clients “Live Well” during their retirement years. This may include significant tax reduction on retirement plans, leaving more money available for his clients enjoyment. Or it could mean portfolio optimization techniques that guarantee your principal while simultaneously maximizing growth opportunities. Additionally, it might include income optimization strategies, which guarantees your income while keeping your tax liability to a minimum.

In addition to his financial advisory practice in Traverse City, he also assists other financial advisors throughout the country by being the featured educator at Advisor’s Excel’s “IRA College” in Topeka, KS. At the “IRA College”, Mr. Reese teaches top financial advisors throughout the country a number of tax planning strategies that he uses to significantly reduce the taxation on his client’s retirement plans. He’s also a featured speaker at multiple industry events.

Mr. Reese lives in Traverse City, MI, with his wife Becky, and their 5 children.