Financial Professionals


What Does the Stock Market Owe You?


The following blog was originally posted on

A short answer: Nothing.

A longer answer: History teaches us that over long periods of time, stocks tend to—but don’t always—pay us something for taking the risk of buying shares in publicly listed companies. You buy things from Amazon [AMZN], Netflix [NFLX], and Apple [APPL] because you value consuming them; you buy their stocks because you want to make money.

But how much should we expect to make? As one might guess, that’s difficult to pin down.

To get at this, let’s first clarify our playing field. The stock market is a decentralized mechanism for coordinating billions of daily individual or computerized decisions to buy or sell shares of stocks, which are tiny slices of ownership in those companies. The reasons why buyers and sellers do so are mostly unknowable and unimportant. One wants to sell, the other to buy, and the laws of supply and demand direct the price at which they transact.

Somewhere in this impenetrably complex mechanism of price discovery, each of us makes a ballpark assumption that our portfolio of stocks will give us a decent return over some period of time, a return that compensates us for the impossibility of actually knowing what that return will be. For most of us, it is faith, not complex statistical algorithms, that leads us to believe that this will somehow work out all right.

For professional traders, figuring this all out is daily sport. For the rest of us, it’s a means—confusing as it is—to grow our wealth in order to support our families and retire comfortably.

I opened with a glib answer on what the market owes you for taking the risk of owning stocks (“nothing”), because as a disembodied thing, the market can’t care about your particular needs. But in fairness, there is a very serious and legitimate question here: If you’re going to bother taking the risk, what are some reasonable expectations for what you will earn? And over what time periods?

So let me ask a basic question: What has the stock market returned over different time periods?

With thanks to my friend and colleague at Virtus Investment Partners [VRTS], Mick Davis, here’s a picture that helps us get at the answer. It encompasses daily snapshots of the total return (i.e., dividends included) of the S&P 500®, a broad index of U.S. stocks, from 1928 until today.

Source: Bloomberg, data from December 30, 1927 to May 31, 2016.

Reading the picture from left to right, what you’re looking at are “rolling” time periods of increasing duration. A rolling time period thinly slices our windows on market returns over whatever period we choose to define them. So, for example, a rolling three-year period could be the market returns from November 1, 1953 to October 31, 1956. The next three-year period would be November 2, 1953 to November 1, 1956. And so on. I looked at the rolling returns over periods ranging from one to ten years in length. All in, it encompasses tens of thousands of observations.

An added benefit of this exercise is that it gets us away from the lazy habit of looking only at calendar year returns. For example, we can say that the S&P 500 was up 13.6% in 2014 and then up 1.2% in 2015. While true, it’s also arbitrary to just look at the market from January 1 to December 31 of each year and leave it at that. If we only looked at calendar year returns back to 1928, we’d have 88 snapshots. I’m making our perspective more comprehensive and reliable by including thousands of snapshots.

There’s a lot to learn from this picture:

  • Notice that the average return over these different periods is remarkably consistent. It’s about 10%. Not surprisingly, many people reflexively believe that “the market” returns about 10% per year. They’re not whistling Dixie. Based on history, that’s about right.

  • Yet that mode of thinking—asking “what’s the average?”—reflects the brain’s bias toward locking onto specific point estimates. We prefer to fixate on a precise number and reject, often subconsciously, thinking in statistical, probabilistic terms. In other words, we don’t naturally play the odds. Sure, to say instead that the market returns “about 8-12%” per year is a baby step in the right direction. Unfortunately the world is much messier than that. The following observations, therefore, force us out of our comfort zone, as they force us to think in terms of dynamic ranges and probabilities.

  • For each of the rolling periods, I show the maximum and minimum returns: the biggest gains and the biggest losses. Thus, over thousands of rolling one-year periods going back to 1928, the largest one-year gain was 171% and the largest one-year loss was -71%. This range is massive. (Note that the most extreme results occurred during the 1930s.)

  • What this tells us is clear: In the short term (please forget days and months, even a year counts as short term), stock market returns are extremely volatile; they are basically random. The fact that the rolling one-year “average” is around 11% tells you nearly nothing about what the market can and will deliver you. Over the past century, we’ve seen one-year periods when some investors nearly tripled their money, while others lost more than two-thirds of it.

  • But then look what happens next, as you read from left to right. With each wider window of time, the average return hardly changes, but the variability of outcomes narrows. There’s still a strong dose of randomness, but less at every step along the way. When you get to five-year periods, the largest historical annualized gains and losses are “only” (ha) 33% and -23%, respectively. At the ten-year mark, certainly what we would consider the “long run,” the range of outcomes grows much tighter. That said, observe that even over an entire decade, stocks have delivered negative returns. The worst ten-year period ever was from May 1930 to May 1940, when stocks lost on average 8% per year.

  • We could extend this exercise over longer and longer periods. One interesting question: What’s the shortest rolling time period over which the S&P 500 has never had a negative annualized return? The answer is 19 years, 11 months. In other words, in history, no one who has held the S&P 500’s stocks for at least 20 years has lost money.

No reasonable person would think that because the market trends upwards it must go up every day. At the same time, we’d all think that over the long run the market should generate a decent return. If the market doesn’t pay a premium for risking our hard-earned money, why bother?

The tough part, for which there is no clean answer, is what we mean by “long run” and “decent.” We are often harangued by academics and purists to “invest for the long term.” Beyond the emotional difficulty of doing so, it’s also true that sometimes the long run is really long. (One sad example is that the Japanese stock market is now at roughly the same level it was at in 1986).

There’s a steady stream of evidence suggesting that even in today’s lower growth world, investors still expect about 10% per year returns. I happen to think that’s unrealistic, but for now, what I hope this exercise demonstrates is that for volatile assets like stocks, there is a ton of variability—especially in shorter time periods. Because we tend to be happiest when future reality matches current expectations, we should all make the best effort to accept that there’s a certain level of randomness to market returns. Sometimes unpleasant truths crowd out comforting beliefs.

Past performance is not a guarantee of future results.

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.