Dec 302010

What market return should we expect over the next 10 to 20 years?

Reviewing the Campbell-Shiller Data

What return should you expect to get on your stock market investments over the next 10 to 20 years?  According to data compiled by Yale University’s Robert Shiller, the average annual real return (i.e. after adjusting for the effects of inflation) on an S&P500-like portfolio over the past 139 years has been 8.2%.  The geometric average annual real return, which is a better indication of the real return realized by a buy and hold investor, was 6.6%.  You might think that these numbers would provide a reasonable estimate of future market returns.  However, all stock market eras are not created equal.  In fact, if we look at the cyclically-adjusted price-earnings (CAPE) ratio and the subsequent 10 or 20 year market return, we can see that times of high market valuation (high CAPE ratio) have been followed by periods of low market returns, and periods of low market valuation (low CAPE ratio) have been followed by periods of high returns.  This relationship is clear in the graphs below. 

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