Tuesday, March 17, 2009

Market Returns: Fun Fact of the Day

Market datapoint of the day: used to be said that if you stayed fully invested in the stock market—reinvesting all dividends, then over the long pull you could expect an annual yield of about 9 percent. So figure 30 years: (1.09)^30=13.268. Peg that number at the peak of the Dow, October 9, 2007. But the market has fallen by half since then. So, figure 13.268/2=6.634. Take the mean annual return from that new lower rate: 6.634^(1/31.5)-1= 6.19 percent (31.5 because we are 1.5 years past the peak).

But we have to account for inflation. Go to the Bureau of Labor Statistics Consumer Price Index data. Take the latest number: 211.143, for January, 2009. Divide by 58.5 the number for January, 1977. You get 3.61. Compute 3.61^(1/32)-1 and you get an average annual inflation rate of 4.09 percent.

Now divide 1.0619 by 1.0409. You get 1.02016. So, a 2 percent average annual return for being fully invested over 30+ years.

Oh, and I forgot about taxes…

[For comparison, the implied (real) return from 30 years to the top of the market is about 4.7 percent. Which actually sounds a bit high to me. But then there’s taxes...]

And did I mention (yes I did, but I’ll repeat it)—invest $1,000 with Bernie Madoff. Collect 10 percent ($100) each year for 20 years. Then discover you cannot recover your capital. You still have an implied annual return of 7.75 percent (nominal pretax). Doesn’t make you happy though, does it?

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