Do Stocks Return 10% on Average?

Summary

In this insightful video, Ben Felix from PWL Capital challenges the common belief that stocks will return 10% or more per year on average, explaining that this expectation may lead to misguided financial decisions. He delves into the history of stock market returns, highlighting the difference between nominal and real returns, and emphasizes the impact of inflation on investment gains. Felix also critiques the reliance on recent U.S. market history for setting future expectations, citing research that suggests more modest long-term returns. He advocates for a more realistic approach to estimating expected returns, considering global stock performance and current market valuations, ultimately advising investors to prepare for lower than anticipated stock returns.

Takeaways

• 🧐 The common belief that stocks will return 10% or more per year on average is often misguided and can lead to poor financial decisions.
• 📈 The origin of the 10% return figure is based on US stock market performance from 1950 to 2023, which may not be a reliable indicator for future returns.
• 🔄 It's crucial to differentiate between nominal and real returns, with real returns being more reflective of actual purchasing power and thus more important for investors.
• 🌐 The real return on US stocks from 1950 through 2023 was 7.63%, indicating that even exceptional returns should be viewed in real terms.
• 📊 Rising stock valuations, driven by falling discount rates, suggest lower expected returns in the future rather than higher, contrary to investor expectations.
• 🔍 A 2002 paper by Eugene Fama and Ken French suggests that the higher returns post-1950 are due to rising stock valuations and not necessarily sustainable for future investment strategies.
• 🎯 The historical US equity risk premium for 1872 to 1950 is close to the realized premium over the same period, suggesting that past performance should inform future expectations.
• 🌍 Global stock returns, excluding the US market, have been lower, with an average real return of 4.35% from 1900 through 2023.
• 🤔 The 'equity premium puzzle' refers to the higher than predicted returns of the US stock market, which researchers attempt to resolve by examining global data and considering economic models.
• 📝 PWL Capital uses a comprehensive approach to estimate expected returns, considering global historical data, removing valuation changes, and accounting for current market conditions.

Q & A

What is the common belief about stock returns that Ben Felix addresses in the video?

The common belief that Ben Felix addresses is that stocks will return 10% or more per year on average, which he suggests is misguided and can lead to poor financial decisions.

What does the nominal return of 11.32% for US stocks from 1950 to 2023 not account for?

The nominal return of 11.32% does not account for inflation. It is important to consider real returns, which do take inflation into account, as they provide a more accurate picture of the actual value growth of investments.

What is the real return on US stocks from 1950 through 2023?

The real return on US stocks from 1950 through 2023 was 7.63%. This figure is adjusted for inflation, providing a more accurate measure of the growth in value of these investments.

What does the term 'Equity risk premium' refer to?

The Equity risk premium refers to the excess return that stocks provide over and above the return on risk-free assets, such as government bonds. It compensates investors for taking on the additional risk associated with investing in the stock market.

Why do rising stock valuations suggest lower expected returns?

Rising stock valuations suggest that stocks are currently expensive relative to their earnings or assets. High valuations imply that a significant portion of the potential for growth in stock prices has already been realized, leading to the expectation of lower future returns.

What is the 'rear view mirror bias' in investing?

The 'rear view mirror bias' is the tendency of investors to assume that the high returns experienced in the past will continue indefinitely into the future. This bias can lead to overconfidence and unrealistic expectations about future investment performance.

How does the concept of 'survivorship bias' affect historical equity premium calculations?

Survivorship bias occurs when the analysis focuses only on companies that survived over a certain period, leading to an overestimation of the historical equity premium. This is because failed or underperforming companies are excluded from the sample, which can skew the results to appear more favorable than they actually were.

What is the historical real return on global stocks from 1900 to 2023, excluding the US market?

The historical real return on global stocks from 1900 to 2023, excluding the US market, is 4.35%. Including the US market, the figure is 5.16%.

What is PWL Capital's estimated real expected return for a total market index fund portfolio?

PWL Capital's estimated real expected return for a total market index fund portfolio is 4.62%, with a nominal expected return of 7.24% assuming an expected inflation rate of 2.5%.

Why is it important to have accurate estimates of expected returns for financial planning and portfolio management?

Accurate estimates of expected returns are crucial for making informed financial decisions. They impact how much an individual needs to save for retirement, how much they can spend during retirement, and when they can retire. Over time, even small differences in expected returns can lead to significant changes in these outcomes due to the compounding effect.

How often does PWL Capital update its estimates for expected returns, and where can these estimates be found?

PWL Capital updates its estimates for expected returns twice a year, and these figures are made available for free on their website.