Six Common Myths about Stock Market Returns
We have found that most investors have quite exaggerated views about long term stock market returns, mainly believing they are much more erratic than they are.
Here are the facts regarding some of the most common misconceptions and myths of stock market returns.
1. Stock market returns are random.
Most people believe that market returns are essentially random. They believe that the odds of a losing year are always the same, regardless of what happened the previous year. However, the facts do not support this.
A statistic often quoted to encourage investors to stay invested shows how much lower your returns would be if you miss the “10 best days” (or weeks, months, or years). The counter argument by active day traders is that their returns would be much higher if they could miss the 10 worst periods.
The truth is that both are hard to do because the best and worst years are usually within 1-2 years of each other. The losses over 20% since 1871 are 1907, 1930, 1931, 1937, 1974, 2002 and 2008. The gains over 25% include 1908, 1927, 1928, 1933, 1935, 1936, 1975, and 2003 (and 20 other years). 1
Note that every one of the losses over 20% had a gain of over 20% within 1-2 years!
Years with large losses have consistently either:
- had large recoveries the next year (1907, 1931, 1974, and 2002), or
- followed years of high growth (1930 1937) and so probably started over-valued.
This pattern is consistent and proportional. The only calendar years with losses over 30% were 1931, 1937 and 2008, but there were gains over 30% in 1927, 1928, 1933, 1935 and 1936. 1
While short term market moves (weeks or months) may be quite random, this close linking of years with large losses years to large gains is clearly not random.
2. Bear markets happen every 3-4 years.
While the market has declined every 3.5 years (39 declines of 138 years since 1871), 1 there have been only 5 bear markets (declines over 20%) in the U.S. and 9 in Canada since 1950. 4 This is an average of one bear market every 12 years in the U.S. and one every 7 years in Canada.
While this is less often than most investors believe, market declines and bear markets are a regular part of long term investing. The cost of getting the high, long term returns of the stock market (11%/year since 1950) 4 is being able to stay invested through a negative year every 3.5 years on average and bear markets every 7-12 years.
Related read: How the stock market works in Canada
3. Real estate returns are higher than the stock market.
First, most people know that stock market returns long term are much higher than other major asset classes.
Even though GICs, real estate and gold have just had what we believe are the best 30 years ever and the period of time we looked at was at the bottom of the 2008 stock market decline, Canadian stocks have still had total returns 2.6 times GIC returns, 4.3 times real estate returns and 4.6 times the growth in gold. From 1977-2007, the stock market returns were 6.5% times the growth in real estate. 4&5
In the last 60 years, $100 would have grown to $49,000 in the MSCI World index (global stocks) compared to only $6,000 in GICs and $7,000 in Canadian bonds 3. We do not have the equivalent growth in real estate, but it has been lower than the GICs.
This is a huge factor for retirement planning. This is why stock market investments are generally recommended for the core of any long term investment portfolio.
We are always surprised how many people actually believe real estate returns have been higher than stock market returns, when in fact they are lower than GIC returns! People do tend to make money in real estate, but that is almost entirely because the leverage factor from having a significant mortgage.
Almost every story we have heard over the years of people making money in real estate in the Toronto area (other than flipping) is really a story about borrowing to invest. For example, putting $80,000 down on a $400,000 home.
The actual growth of real estate has been about 2% over inflation, which is far less than the stock market. 4&5
- Fixed income faceoff– Bonds vs. GIC vs. High interest savings accounts
- Investing in Canadian dividend stocks
- Should you buy a house in Canada?
4. Stock market returns are erratic and unpredictable, even long term.
The most significant misperception about stock market returns for most people is not understanding how consistent they have been over long periods of time. For the three 70-year periods, returns have been almost exactly the same between 6.6%-7.0% above inflation. 2
Even when you invest for only 20 years, the worst-ever total return outside of the 1930s is 5%/year (3.1%/year including the 1930s). Since 1950, the worst 20-year period was still a gain of 6.5%. This is not a great return, but pretty good for a worst-case scenario! 1
The stock market is very erratic and unpredictable short term, but long term it has actually been quite predictable.
5. The U.S. stock market is unique and stock markets around the world are much less consistent.
All our statistics have been about the U.S., because we have the longest data about the U.S. However, the U.S. has been the most successful world economy over the last 100 years. How does their stock market compare with other countries around the world?
In comparing 16 major countries from 1900-2000, the conclusion is that “the United Sates has not been the best performing equity market, nor are its returns especially out of line with the world averages.” 6
6. Bonds and cash are safe.
Bonds and cash are much safer than stocks short term, but their returns can be wiped out by inflation. Inflation is a critical factor for investing. Protecting and growing our purchasing power are the objectives of investing.
Quite surprisingly, after inflation, the worst 10-year period for bonds and cash since 1802 is worse than any 10-year period for stocks! 2
This is especially true in hyper-inflation, where the bonds of a few countries have essentially gone to zero or near zero, including, Germany, Japan, France and Italy.
Nearly every country in the world has had a 25% 1-year loss after inflation with their government bonds, including Australia, Belgium, Canada, Denmark, France, Germany, Ireland, Italy, Japan, South Africa, Spain, Sweden and the U.K. The worst loss after inflation for government bonds in the U.S. was 19.3% in 1918 and in Canada 25.9% in 1915. 6
During periods of inflation, companies (and industries) tend to increase their prices to keep their profits rising with inflation. This is why stocks tend to keep up with inflation over time, but bonds and cash tend to lose their purchasing power. If you own bonds or cash, you should fear inflation.
Part 2: Common Myths about Stock Market Risk
1 Our own research by analyzing the calendar total returns of the S&P500 in US dollars since 1871.
2 Classic book “Stocks for the Long Run” by Prof. Jeremy Siegel that has data from 1802-2006.
3 Morningstar as shown in Andex Charts.
5 Toronto Real Estate Board.
6 Book “Triumph of the Optimists” by Elroy Dimson, Paul Marsh & Mike Staunton
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the only people that make money in the stock market are essentially inside traders. To think it is just a person making the right choice?. I have some houses in Florida to sell you to. Give me a break. How does a guy sit around his table with his lap top after a day at work and suddenly know how and where to invest?. Answer he doesn’t and never will. Hence the wealth is accumulated and kept by about 5% of the worls population. 1) if your a regular guy first admit it, I ain’t going to get rich, 2) put your hard earned money into GIC and high interest saving account have cash flow and save the money (what little you have) for your family. Nuff said
Yes. Bonds have higher returns when interest rates fall and lower rates when interest rates rise. We have seen interest rates fall nearly every year since 1982, but they probably were at the low last year.
Bonds have kept up with stocks in the last 10 years, but their returns are 1/5 of Canadian stock market returns and 1/8 of international stock market returns since 1950.
In the long run, bond returns must be lower. Companies borrow by issuing bonds to invest in their operations. If companies did not believe their stock would outperform their bond, they would not ever issue bonds. The fact that corporate bonds exist proves that the companies that issue them believe their stocks will outperform those bonds.
A quick look at TD Canadian BOND Index VS. TD US Index CN, TD International
Index CN and TD Canadian Index respectively, shows bonds beat stocks hands
down over same period (since 2000).
Am I missing something?
You can compare: http://www.tdcanadatrust.com/mutualfunds/perforFrame.jsp
Bonds vs.Stocks: Here is another interesting post:
10% gross on the value i paid for it.
6.7% gross on what it is now worth (my best guess) or 5.2 % net
of course it isnt paid off so the return is higher then that
Your property pays 10% income on the full value of the property? Or are you just calculating that on your equity?
Our experience is that high returns on real estate are nearly always really a low return on the investment plus a high leverage factor.
Re:Man From Atlantis
As a matter of fact i do know those numbers.
gross works out to be a 10% return or 7.8% after tax
(income with no vacancy)
with my new property which i paid lot more for…it would work out to 6.5% gross or 5% after tax
*these number only based on only income …..not including appreciation
Rents and home prices usually balance out over time. Otherwise, it becomes too advantageous to be an owner or a renter. In Toronto recently, home prices have risen quite a bit quicker than rents. Renting is generally quite a bit cheaper than owning the same property. This can only be maintained if prices keep rising.
Thanks for the stats. That’s very interesting.
Part 3 is already posted.
Hi Doc Stock
We call GICs “Guaranteed Insufficient Cash”.
GICs and cash are generally safe, other than they get killed by inflation. But the bigger issue with them is that they are essentially useless in retirement planning.
We find that almost anyone that wants to just maintain their existing lifestyle (less the mortgage and kids costs, plus a bit for some travel) would have to invest a ridiculous amount (say 30-50% of their gross income) in order to build up enough of a nest egg.
With rates of 5% or less in the last decade, hardly anyone can have the retirement they want with returns that low.
Hi Cash Back,
Scores on the quiz seemed to be in 2 main groups – those that published their score, most of which said they scored 9 or 10 of 12, but all said they guessed on a few – and those that sent me private notes, most of which scored 2 of 12.
I have the feeling that many in the first group exaggerated or marked themselves very easy.
Our belief was that most investors know little about the market and have an exaggerated view of the risk. This was not a proper study, but it seems our belief is true.
We expected that most people would get a low score. I realize most people would not necessarily know the answer, but the idea was to take an educated guess to see if your general perception is close.