Investors often ask, “What kind of gains can I count on?” The simple answer is that stocks have rewarded long-term holders with roughly 10% per year on average, yet that smooth figure hides wild swings in between. By unpacking historical data, understanding risk-adjusted measures and applying forecasting models, you can form realistic expectations and build a plan to capture returns without being derailed by volatility.
1. Historical Averages: A 100-Year Perspective
Data going back to 1928 shows a nominal annual return of about 10.1% for the broad U.S. market (as measured by large-cap indexes). From 1957 onward the S&P 500 posted roughly 10.5% including dividends. Over rolling 5- and 10-year periods, however, annual returns have ranged from –8% to +30%. The lesson: single-year outcomes are unpredictable, but over decades the market has reliably compounded wealth.
2. Real vs. Nominal Returns
Inflation erodes purchasing power, so the average real return (nominal minus CPI inflation) is closer to 6–7% per year. From 1957 to 2024, U.S. inflation ran about 3.8% annually, leaving a 3.8% real gain for patient investors. This still outpaces bonds and cash, making equities a compelling long-term growth engine despite short-term discomfort.
3. Understanding Volatility and Drawdowns
- Standard Deviation: Historically around 15%–17% for large-cap stocks, meaning annual returns often stray ±15 percentage points from the average.
- Max Drawdown: The worst peak-to-trough loss in history was about –83% during the 1929–1932 crash. In recent memory, the 2008 bear market pulled the S&P 500 down ~57% and Covid-19 sell-off wiped out ~34% in weeks.
Volatility is the price of equity’s higher long-term return. Accepting drawdowns and sticking with a plan can turn temporary plunges into buying opportunities.
4. Forecasting Future Returns
Past performance isn’t destiny, yet forecasting tools can guide expectations:
- Dividend Discount Model (DDM):
Estimate return ≃ dividend yield + expected earnings growth. With the S&P 500’s current 1.8% yield and a long-term 6% earnings growth forecast, returns may hover near 8%–9%.
- Capital Asset Pricing Model (CAPM):
Expected return = risk-free rate + beta × equity risk premium. With today’s 10-year Treasury at 4.5%, a market risk premium of 4.5% and β≈1, investors demand about 9% annual return.
- GDP Growth Link:
Nominal GDP rises roughly 4%–5% annually; corporate profits track the economy over time. Adding a 4% equity premium suggests 8%–9% potential return.
These frameworks point to below-10% future averages, especially after a decade of strong gains. Adjusting for valuation extremes (e.g. high P/E ratios) may push expected returns even lower in the short term.
5. A Step-By-Step “How To” for Your Return Estimate
- Pick your benchmark (S&P 500, MSCI World).
- Gather inputs: current dividend yield, long-term growth forecast, risk-free rate.
- Apply DDM:
Return ≃ Dividend Yield + Growth Rate. Example: 1.8% + 6% = 7.8%.
- Use CAPM:
Return ≃ 4.5% + 1.0×4.5% = 9.0%.
- Blend models:
Average your DDM and CAPM outputs for a 8.4%–8.8% expected range.
- Factor in valuation:
If P/E > 20×, subtract 1–2 percentage points; if < 15×, add 1–2 points.
6. Let Me Show You Some Examples …
- In 2000, the S&P 500’s forward P/E peaked above 25×. Forecast models at the time predicted sub-5% returns over the next decade—which proved accurate: 2000–2009 saw a full-cycle return near 0%.
- From 2009 onward, valuations were lower and DDM/CAPM pointed to 7%–9% potential. Actual 2010–2019 returns averaged ~13% annually, helped by multiple expansion and faster earnings growth.
- After the Covid trough in 2020, all models anticipated 7%–10% returns; the next three years delivered ~15% annualized as economies reopened and fiscal support boosted profits.
7. Tailoring Expectations to Your Time Horizon
Short-term (1–3 years): returns may stray ±20% or more from forecasts. Medium (3–7 years): range tightens to ±10%. Long (10+ years): historical averages near forecasts prevail, smoothing out volatility.
8. Conclusion
No forecast is perfect, but combining historical context, valuation-adjusted models and clear time horizons yields realistic return expectations in the 7%–10% annual range. By anchoring your plan to these figures, you can set achievable goals, maintain discipline during downturns and compound gains over decades.
