Long Term Returns: What's Realistic And What's Not?

And from what I've gathered from the letters received in the Working Money offices, my expressed viewpoint has been solidly supported. There has been a detractor or two, to be sure. One of the most vehement was from a reader who took issue with my using a constant return of 10% per year as an example. His complaint was that the market fluctuated wildly and that real-world percentages should be used instead of the hypothetical constant of 10% a year. The market does fluctuate, and sharply, I must agree; the sad truth is that sometimes the market does crash, and when it does, it takes all of the averages down with it.

The letter-writer went on to compare some real-world figures against the constant I had used. At the end of a 20-year comparison of $10 investments, the real-world returns came to just under $60, while the constant 10% return was just over $67. Interestingly, his calculations began in a year with a 15% negative real-world return. If he had started his calculations just one year later, his total would have been considerably higher than the constant!

His point was well taken, however. How difficult is it to get an average return of 10% on your investments? What I discovered, with just a little surfing around the web, surprised me. Some of the short-term returns (10%) I found were phenomenal, but even the long-term returns of some mutual funds have been far greater than 10%. (See Figure 1.)

GETTING YOUR 10%

One of the first things that became apparent during my research was that mutual fund evaluations, whether you get them through a brokerage or a search engine, are often based on information from Morningstar, Inc., a leading provider of mutual fund, stock, and variable-insurance investment information. Thus, it seemed only sensible to go directly to the source. Looking at various lists of mutual funds with the Morningstar.com ranking tools resulted in quite a list of funds with 10-year annualized returns of not just 10%, but more than 20%. (See Figure 2.)

And here's something else that became evident looking at a list of US equity mutual fund returns: a lot of red ink. It was clear that many of the funds that flew so high during the last couple years of the long bull market have lost a big chunk of their winnings thanks to the bite of the bear, proof yet again that the market doesn't always go up. Sometimes it goes sharply and deeply down - the prime reason that I write a lot about long-term investing.

I also decided to look at bond funds? in my research. I was not expecting to find double-digit returns in that area, but I did find some that were above the 10% bar. (See Figure 3.) Even with the ups and downs of the market, the Vanguard 500 Index Fund has managed an average annualized return of not 10%, but nearly 15% since its inception in 1976. (See Figure 4.) And it has done so with one of the lowest management fees in the industry. It doesn't take a financial genius to buy and hold that fund and just follow the market.

If an index fund isn't your cup of tea, there are a number of other low-cost funds with long-term returns that are above the 10% mark. (See Figure 5.) While buying and selling individual stocks can eat up a lot of the market's average 10% returns, buying and holding a solid-performing no-load fund should keep you closer to a 10% constant.

The last point that needs to be addressed is inflation. I wish I could tell you the 10% constant was adjusted for inflation, but it was not. That said, saving some of your income now in a tax-deferred Ira will at least help you keep up with whatever inflation there will be in the future. Even with inflation eating some of your savings, in the long run you are better off with a growing savings account than you are without one.

KEEP THIS IN MIND

Yes, there will be times when the market has big losses, which will be reflected in your overall return percentages. Yes, inflation will eat a big chunk of what you save. Yes, either now or later, depending on the type of Ira vehicle you use, taxes will shrivel what you have worked so hard to save. But in the long run, the positive trend of the market - and your intelligent choice of investment in same - should provide the overall 10% return used as the benchmark in my articles. Those inflation-ravaged, tax-attacked savings will still leave you much, much better off on the day you retire than the spend-now, hope-for-the-best alternative.

Bruce Faber can be reached at BFaber@Traders.com.

SUGGESTED READING

Faber, Bruce R. [2001]. OThe Money Tree Grows Slowly - At First,O Working Money, Volume 2: March.

Copyright © 2001 Technical Analysis, Inc. All rights reserved.