The economy and stock market are unpredictable, and investors are not putting much weight on a macro environment where a possible recession could depress earnings across different sectors. Conflicting views on the timing of such an upcoming recession are prevalent.
The Federal Reserve recently paused rate hikes at its June meeting, and though it has expressed the likelihood of more rate hikes in the future, its interpretations of the economy at the next meeting in July may impact investor sentiment.
This year’s equity rally was primarily driven by the tech sector, leaving questions about whether the bull market is mostly a temporary momentum shift initiated by the readjustment of a previously depressed tech sector combined with an interest in artificial intelligence, or whether it is a sustainable growth vehicle to jump on.
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Amidst the complicated and often conflicting data, many investors rely on the fact that the stock market has historically proven itself dependable, and that sticking with the market during its ups and downs is a good way to achieve sustainable returns in the long run.
In this piece, we will investigate the average stock market return of different stock indexes over time. And we will scrutinize an oft-repeated phrase: “Past performance is no guarantee of future results.”
Average Stock Market Return Over the Last 30 Years
Over the last 30 years through June 29, the Nasdaq Composite index, which contains over 3,700 stocks listed on the Nasdaq stock exchange, has returned a cumulative total return, which includes dividends, of 1,839%. Since 1983, it has yielded 4,198%, and in the last decade, it gained 299%. The Nasdaq has an average annualized return of 10.4% for the past 30 years.
On the other hand, the S&P 500 — an index that tracks 500 leading companies listed on U.S. stock exchanges — gained a cumulative 875% over the last 30 years. Since 1983, it gained about 2,538%, and in the last 10 years, it increased by 174%.
The S&P’s annualized average return for the past 30 years is 7.9%. From the time it adopted 500 stocks into the index in 1957 through June 29, 2023 it has an average total return of 7.2% annualized, including reinvested dividends.
What Accounts for the Difference?
The historically superior performance of the Nasdaq is due to its higher weighting of the fast-growing technology sector. This sector makes up over half of the Nasdaq index. On the other hand, S&P Global Inc. (ticker: SPGI), which maintains the S&P 500 index, reports that technology makes up 28% of its weighting.
And indeed, one popular measure of the tech sector, the Vanguard Information Technology Index Fund ETF (VGT), returned about 944% since it began trading in 2004. By comparison, the S&P 500 returned about 288% and the Nasdaq about 558% over the same period.
Some of the disparities between the Nasdaq and the S&P 500 also result from the impact of small- and mid-cap stocks, since the S&P 500 does not include this range of market capitalization with a higher growth potential.
Past Performance Is No Guarantee of Future Results
You’ve probably heard this phrase if you’ve ever researched how to invest. But is looking back in time useful for investors?
William Sharpe, who won the 1990 Nobel Prize in economic sciences, put a finer point on the concept: “While results vary from asset class to asset class and from time period to time period, experience suggests that for predicting future values, historical data appear to be quite useful with respect to standard deviations, reasonably useful for correlations, and virtually useless for expected returns.”
The fundamental idea behind Professor Sharpe’s description is that past performance helps determine how risky an investment is and how it moves with other investments. However, it is of little use when trying to figure out where a stock’s price will be in the future.
Other methods, such as value investing, may have other analyses that are more commonly accepted as methods of predicting whether returns will generally be higher in the future or not. However, these methods rely on the fundamentals of the business and not its stock price.
The best thing that we can do is to analyze past volatility and correlation of stocks to construct well-diversified portfolios. A well-diversified portfolio is constructed of assets that will, ideally, balance out each other’s movements.
Another popular tool to gauge the return relative to the risk of a portfolio is the Sharpe ratio, which divides a portfolio’s excess returns over a safe investment by its standard deviation. A higher ratio, therefore, corresponds with a better investment as it implies that one can obtain higher returns without significant additional risk. With that being said, a risk to the Sharpe ratio is that it can be manipulated by using long histories of returns, which will decrease the standard deviation of returns.
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Alternative Investments
With all that being said, the popularity of equities and bonds in portfolios means that many investors end up investing in alternative assets, such as real estate or commodities, that can provide diversification. And while many of these alternative investments have historically inferior returns compared to equities, it is important to remember that past performance does not guarantee future results, and there are times when alternatives do outperform equity markets. Furthermore, alternatives are historically uncorrelated with equities and so their arguably greater value is in providing diversification for a portfolio.
Real Estate
Many real estate investors will focus on a few select projects. However, that doesn’t mean that real estate investing isn’t available to anyone other than the wealthy. For instance, the Vanguard Real Estate Index Fund Admiral Shares (VGSLX) has a cumulative total return of 426% since it began trading in late 2001.
The S&P 500’s return was 291% during the same period, including reinvested dividends. This type of alternative investment’s value also comes from its ability to diversify your portfolio. Real estate tends to be less volatile than equity investments because its value is tied to a tangible asset and so it is less affected by the business cycle.
Commodities
While commodities may not be the best growth investments, they can be a great way to hedge against inflation, since inflation is in part driven by the increased price of commodities. Furthermore, commodities are another great way to diversify a portfolio.
Funds like the Abrdn Bloomberg All Commodity Longer Dated Strategy K-1 Free ETF (BCD), which has gained a cumulative 50.5% since its inception in 2017, can be a worthwhile investment for investors who care less about aggressive growth and more about diversification and hedging against large swings.
Private Equity
While private equity is largely associated with the ultra-wealthy, the qualifications for investing in it are accessible to a surprisingly large portion of the U.S. population. About 10% of households in the U.S. were accredited investors in 2020.
Stephen Nesbitt, CEO and chief investment officer of Cliffwater, describes the outsized returns of these investments: “Over a 21-year time period ending June 30, 2021, private equity allocations by state pensions produced an 11% net-of-fee annualized return, exceeding by 4.1 (percentage points) the 6.9% annualized return that otherwise would have been earned by investing in public stocks.”
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What Is the Average Stock Market Return? originally appeared on usnews.com
