I am going to take a little detour this weekend from the usual macroeconomic/market analysis to dispel a few “Wall Street” myths about long-term investing.
1) The Market Has Generated 10% Annual Returns
One of the biggest myths perpetrated by Wall Street on investors is showing individuals the following chart and telling them over the “long-term” the stock market has generated a 10% annualized total return.
an AVERAGE return of 10% per year. Historically, 4%, or 40% of the total return, came from dividends alone. The other 60% came from capital appreciation that averaged 6% and equated to the long-term growth rate of the economy.
However, there are several fallacies with the notion that if you invest in the markets long-term you will continue to accrue a 10% annualized rate of return.
1) The market does not return 10% every year. There are many years where market returns have been sharply higher and significantly lower.
2) The analysis does not include the real world effects of inflation, taxes, fees and other expenses that subtract from total returns over the long-term.
3) You don’t have 144 years to invest and save.
The chart below shows what happens to a $1000 investment from 1871 to present including the effects of inflation, taxes, and fees. (Assumptions: I have used a 15% tax rate on years the portfolio advanced in value, CPI as the benchmark for inflation and a 1% annual expense ratio. In reality, all of these assumptions are quite likely on the low side.)
As you can see, there is a dramatic difference in outcomes over the long-term.
From 1871 to present the total nominal return was 9.07% versus just 6.86% on a “real” basis. While the percentages may not seem like much, over such a long period the ending value of the original $1000 investment was lower by an astounding $260 million dollars.
Importantly, as stated previously, and as I will discuss more in a moment, the return that investors receive from the financial markets is more dependent on the “WHEN” you begin investing.