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FOR ALL INTENSIVE PURPOSES

M O N D A Y, M A R C H 2 9 , 2 0 1 0

What is the Average Return Rate of the Stock Market?

Much ado has been made about the prudence of long-term investing in the stock market. Mutual funds are
often quoted as having 10%/year long-term growth. Burton G. Malkie (author of A Random Walk Down Wall
Street) recommends the average investor would do better by purchasing an unmanaged index fund
(specifically the Wilshire 5000 for the U.S. market) over a managed mutual fund. This post will track stock
market returns by considering historic S&P 500 data from 1871-2009 pieced together by Robert Shiller (author
of Irrational Exuberance). I say pieced together because the modern S&P 500 didn't exist until 1957.

The above graph plots the history of a $1 investment in 1871. The bottom curve (blue) shows the price history
of index, while the top curve (red) shows the price history of an investment with dividends reinvested. The
index itself tracks inflation closely (the index has an average return rate of 3.91%/year -- not much higher
than the 3.26%/year that the CPI data gives). The investment with dividends reinvested has an average annual
return rate of 8.61%/year. To calculate these rates, I took the ratio of the value of the investment at one year
to the value from the previous year. I then took a geometric mean of these values to come up with the
average return rate.

The below graph is somewhat more interesting because it has been CPI-adjusted. All values are given in 2009
dollars.

1 of 3 Once again, the top curve (red) shows the investment history with dividends reinvested, while the bottom 10-03-30 3:23 PM
curve (blue) is an inflation-adjusted price history of the index. In this case the index has an average return
rate of 1.80%/year, while the dividends-reinvested investment has a return rate of 6.41%/year. The following
histogram shows the spread in returns for the inflation-adjusted, dividends-reinvested case:
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