How much money should I be saving? How am I doing? Am I on track to retire with a sufficient nest egg? These are some key questions that investors ask themselves every day. The answers to these questions, more often than not, depends on what happens in the stock market. More importantly, it depends on *what could happen over long periods of time*. To help understand this, we take a detailed look at the long term historical returns of the S&P 500 in this post.

Specifically, it is important to understand the long term historical return trends of the S&P 500 and get insights about what an investor can expect. We also need to understand the impact routine stock market crashes could have on an investor’s portfolio. For instance, what if an investor is just starting to invest now and the market enters a long-drawn bear market? What if they are close to retirement and the same happens?

While the common financial wisdom says “The S&P 500 averages 7% returns annually”, is that *completely* true? Has that ** always** been true across different times in history? If not, how different is it? What can an investor expect?

Let us consider the case of a typical investor. ** A typical investor might invest an amount, say $X, every year for the length of their investing lifetime.** This typically spans about 30 years (the length of a typical earning career). Let us take a look at what returns this investor might have seen historically, depending on what period in history they were investing.

*Yes, the S&P 500 indeed averages 7% CAGR over the long term. However, it is certainly not consistent; even when annualized over the entire 30 year earning lifetime of a typical investor! *

As we see in the above chart, the stock market has gone through different phases. If an investor were to be starting their 30-year investing period between 1929 – 1943 and investing in a disciplined and systematic manner, they enjoyed a healthy CAGR of 8% or higher. Same is the case for investors who were starting their investments between 1966 – 1978. However, if one began investing either between 1945 and 1955 or between 1979 and 1989, they have not been so lucky. The return was only around 5.5%.

**The Variations in Returns**

As one can see in Figure 1, there is significant variation in the returns over different periods in history. Let us quantify it.

The average of the 30 year rolling CAGRs seen between 1928 – 2018 was 7%. However, this was accompanied by a standard deviation of 1.4% (Figure 2). This means that one could say in the average case, the S&P 500 has returned 7%. However, in the case of an “above average” market, the S&P 500 has returned 8.4%, and in the case of a “below average” market, the S&P 500 has returned 5.6%. This is a massive variation, especially when considering that all these returns are annualized over 30 year periods. A 3.2% higher CAGR compounded over a 30-year period could mean a world of difference in one’s total returns.

Over a 30 year period, the above average case of 8.4% CAGR would have implied a 1029% total returns (Figure 3) whereas, the below average case of 5.6% CAGR would have only translated to 423% total returns, at the end of a 30-year investment period. In other words, ** There was a 6x difference in the money one could have at retirement! Just based on the time period they were living in. **So, what gives? Why is there such a big disparity?

**The Key Factor**

To explain the rather large disparity in returns that

We can tie raw returns obtained (Figure 4) with the CAGR (Figure 1) seen in different investing periods. We see that the main factor dictating above/below average returns has to do with (unsurprisingly) stock market crashes/drawdowns. If one experiences a large market drawdown during the middle / late periods in their investing career, it is going to have a significant impact on the total returns they would be able to receive.

There were major drawdowns in the years 1930, 1931, 1937, 1973, 1974, 2002, and 2008. We can see the impact of the drawdowns in the years 1973, ’74, ’00, ’01, ’02, and ’08 in investment periods beginning 1945 to 1955, and 1979 to 1989. During these periods, the market crashes happened during the later stages of the respective 30 year investment periods. In other words, *it might be hard to recover from a stock market crash if it were to happen late in one’s investing lifetime.*

Given the above observations and the rather large disparity in total returns as seen in Figure 3, *it’d be prudent for investors to take the variability in market returns into consideration as they plan their financial future.*

**Different Investment Horizons **

You might be wondering, “What if my investment horizon is 20 years rather than 30 years?” It turns out, the average CAGR hovers between 6% and 7% irrespective of the different investing horizons. However, the important factor is the standard deviation increases drastically as the investment horizon reduces. This gives more reason for an investor to take the standard deviation in returns into consideration as their investment horizon becomes shorter.

Note, this analysis was performed assuming that an investor starts investing with $X and invests $X per year for the length of their investment horizon. For many investors, this might not be the case. As one grows further into their earning years, they probably (ideally) would have a sizeable amount of money already saved up. So they might be starting with $10X or $20X and investing $X every year after that. Such a big skewing would impact both the average CAGR that’s been obtained historically. Furthermore, they can expect the standard deviation to be even larger than what we have seen here.

**Planning for V****ariations**

**ariations**

We have seen the rather large impact the variation in market returns can have on an investor’s portfolio. The question becomes, how can one plan for their financial future in the face of these variations.

Planning for the variations depends on how “*certain*” an investor wishes to feel in planning for their nest egg. One might refer to the percentile CAGR returns as shown in Figure 6 to trade-off their savings contribution with the extent of confidence they can have in meeting their financial goal. Let us take a more detailed look at this with an example. Let us say, two people, person A, and person B had the same investment goal, to begin with. The below table shows how their savings plan might differ.

Person A | Person B | |

Savings Goal | $1,000,000 | $1,000,000 |

Investment Horizon | 30 years | 30 years |

Assumed CAGR P | 20th | 50th |

Assumed CAGR (From Figure 6) | 5.5% | 7% |

Savings Contribution Needed | $200,645 | $131,368 |

Historic Probability of Success | 80% | 50% |

If person A planned their savings assuming only 20th percentile CAGR, it meant that in 80% of the investment periods in history, they would have met/exceeded their investment goals. On the other hand, if person B planned their savings assuming the median CAGR, they would have met/exceeded their goals only in 50% of the investment periods. Person A could be more certain of meeting their investment goals than person B. On the flip-side, by planning for the lower CAGR person A was putting away larger amounts each year than person B, in exchange for the higher certainty. This can be seen in the above table. Therefore, *one could plan their savings assuming a lower percentile CAGR, thereby increasing their savings contributions in exchange for a higher chance of meeting their savings goals. *

**What about other assets?**

A common piece of financial wisdom says “** invest more in bonds as you grow older**“. That intuitively seems like a good thing to do. You can look forward to a deeper data-driven analysis of the subject in a future post.

**Footnotes and Disclaimers**

- All the analysis was performed based on the raw yearly returns data available here and here. The returns considered include dividends and are not inflation adjusted.
- CAGR presented here accounts for the total invested amount over the entire investment period. If the total amount invested is $X, the final portfolio value is $Y and the investment period is N years, then CAGR is calculated as (((Y/(X*N))^(1/N)) – 1)*100
- Past returns do not guarantee future returns.
- None of the statements / data presented here should be considered as investment advice and has been compiled here for educational purposes only.