How come I've been losing 4% per year over the long run in a stock market that returns 10% per year?

One investment philosophy that has grown in popularity is “Because most mutual funds can’t even outperform stock indices, just invest in index funds.” This idea builds on the assumption that “over the long haul, the stock market goes up 10% each year.” Guess what…

The stock market does not go up 10% per year in the long run

  • The math is just plain wrong. Lying averages tell us if you average the annual returns of the stock market it will equal its performance… but, as the name implies, it is not true. Lying averages tell you that if you are aiming for a 10% average return, and you have a 20% loss one year, it will take a 30% gain the next year to get back on track. Truthful math will tell you it will take a 50% gain just to get back on track for a 10% average annual return. Think about that in light of the stock market activity in 2000, 2002, and 2007.
  • Any returns less than inflation is truly a loss. With inflation currently at 11.58%, you’ll need a 21.58% annual return to grow your wealth at 10% per year.

Just look at the last 10 years of data…

On the chart above, the red line reflects the inflation rate as published by the U.S. Bureau of Labor Statistics. This calculation interestingly excludes certain factors such as the price of oil, food, and in the future, anything else that rises rapidly in price due to inflation. Social Security benefits are increased according to figures based on these BLS calculations (you may as well remove the “L”). Most of us actually eat food and use gasoline, so luckily there are other sources that track inflation as indicated by the blue line.

During the last 10 years, there was a stock boom and bust. Overall, the S&P 500 returned 4.18%. As you can see above, inflation during that time fluctuated between 8% and 12%. If you had invested $100,000 into an S&P 500 index fund from 1998 to 2008, this is how it would look:

…a loss of $37,417. So you lost 37% or 3.7% per year rather than experiencing the mythological 10% return of the market.

What if you could earn a predictable income in excess of 10% annually? Would it be worth wiping the slate clean, dropping the conventional adage, and learning how to understand financial statements and private financial instruments? What if you could build your wealth using methods employed for centuries by the world’s wealthiest individuals?

Reader Interactions


  1. Jonk,

    The crack of logic, my friend. Food, gas, gold, and most hard materials have gone up in price much more than 3% per year for the past decade. The government is having a hard time handling their finances – we all know this. Their inflation statistics are used to adjust the Social Security benefits they have to pay out, so there is a conflict of interest for BLS.

    I use independent economic sources (those who don’t have a conflict of interest), such as The blue line on the chart above simply uses calculation methods that BLS used in the 80s, while the red line uses methodology that was radically changed several times in the 90s by Greenspan to exclude things that rise rapidly in price… thus defeating the entire purpose of BLS’s reporting. So you can only believe BLS’s numbers from the 80s if you believe the numbers now. You either have to pay no attention to the numbers at all or pay attention to the consistent calculations – the blue line. I interviewed the economist behind that service on my internet radio show and I’ll add a link here to it soon. I think he can connect the dots much better than I can.

    So we see the price of services staying fairly steady because most businesses who provide services don’t have an economist on staff to alert them to the rate of monetary debasement. Inversely, the hard materials of the earth are rising rapidly in price because the institutional investors (whose large buying and selling decisions affect price) are influenced by the economists they have on staff. So again, when prices are tripling or quadrupling in a few year’s time for the hard materials of our earth, the difficult to swallow claim is that inflation has been around 3%. A little common sense goes a long way. Who do you know whose household expenses have been rising by only 3% for each of the past 10 years?

  2. Jeff,

    I found your blog through a comment you left on Tim Ferriss’ site.

    One of the concepts to be conscious of is that inflation affects individuals in vastly different ways. I don’t buy gold to sustain my life, so the inflationary pressures brought on by the rising price of gold doesn’t drastically affect my purchasing power or my real return. But it absolutely matters, as you say, in the event I want to convert my investments to include a position in gold.

    There is no doubt that gasoline has increased dramatically, but it does not make up a significant part of my overall spending. I’m much more concerned with how inflation affects the cost of my rental, insurance, and my tax liability, as these are the biggest slices of my spending pie.

    So while your inflation numbers of 12% may be valid from a factual and statistical perspective, I believe they do not directly correlate to the inflation pressures encountered by average consumers.

    You have a good blog here. Keep it up!

  3. Thanks, Bill. I’m an avid reader of Tim’s blog, and I’m excited to see him come back to the topic of investing.

    Keep in mind this 12% inflation number isn’t mine. Read

    It’s based on a “basket of goods” and weighted according to how it actually will affect you statistically as an American. Also, the price of gold isn’t going up because people buy it and use it every day… the price of gold has gone up simply because the U.S. dollars are going down in value. If you look at the price of gold in terms of barrels of oil or ounces of any other raw material, it hasn’t really spiked. It just looks like it spiked when you see it priced in USD because the dollar plummeted. The real movement is in the dollar… aka inflation.

    P.S. For the average American consumer, food and energy combined represent 28% of expenses.

    The 3% inflationary figure you may be more familiar with is far from what you actually likely encounter as a consumer. With the BLS new (90s) methodology, anytime something spikes in price (like energy or food) its weight in the formula is then reduced. This same emergency adjustment to the CPI calculation is not performed when the price of an item falls rapidly. Put simply, BLS will adjust one side of the equation regularly to make sure the other side always says 3%.

    Many people’s household expenses have not risen 12% each year because they have reacted by reducing their quality of living (less vacations, smaller house, shorter commute, eating out less, etc.). Regardless of this reduction in quality of living, the value of the dollar is actually declining by double digits every year and it directly affects everyone who buys, sells, or earns in USD.

  4. There’s another odd, pernicious, and, perhaps, unmeasurable inflation going on: the inflation of reduced value.

    The low inflation numbers are supported by the observation that you could go out in 1985 and buy a sofa for $1000. You can go out today and buy a sofa of the same size for $1000 or less, so you have zero or even negative inflation, right?

    Well, sort of… the sofa you buy today for $1000 is a piece of [favorite scatological word here] that will fall apart in a few years; it’s much lower in quality (and hence, value) than the sofa you bought in 1985 for $1000. This same observation holds for almost anything consumable or mechanical (not electronics, though, and electronic stuff comprises an ever-higher proportion of spending) – fruits and veggies are ridiculously cheap, but the only GOOD fruits and vegies come from Whole Foods or the farmers markets, and cost 2-3x what the supers charge. I inherited power tools from my grandfather that I still use, but the ones I buy today last a year or two.

    I don’t know how to measure that kind of inflation, but I know it’s there…

  5. Great point, Bill. It’s that phenomenon that is making it easier for us to ignore inflation. “If a sofa costs $1000 twenty years ago and today, then where’s the inflation?”

    I imagine the inflation of reduced value could only be measured by seeing how much a product costs today that matches the quality of a certain product in the past… but then your are certainly getting subjective. Accuracy and consensus of such a measurement would be difficult.

    Thanks for the valuable input!

  6. OK… Even if you buy the 12% inflation number, I keep coming back to the key premise that most money managers/funds can’t been the indexes (after fees).

    I’d LOVE to know how to consistently pick the funds/managers that can beat the market and can be reactive to a big down market by selling out and/or hedging.

  7. Hi, Glenn. I am sure you’d love to know how to pick funds/managers that can beat the market. Everybody would. The premise of this blog is that doing such a thing is unlikely, complex and/or difficult.

    The proposed solution is unrestricted investment options. Instead of having to pick either individual stocks/bonds or funds of stocks/bonds, a person can simply restructure their retirement account to allow for direct investment into real property, private mortgages, private businesses, private debt instruments and revenue contracts, and any other asset.

    So my what I promote is that a person learn how to understand financial statements and financial instruments. This is a much less difficult task than learning how to understand the stock market. The stock market is this tiny realm inside a huge world of investment opportunities. My blog is about having access to that entire world.

  8. Bill’s point about the increasingly poor quality of many consumer goods is dead on. It is also something ignored by many economists who treat most types of goods as being equal in quality over time.

    For example my grandfather’s late 70s era riding mower was still perfectly functional in the late 1990s. Contrast this with my parents and their neighbors’ struggle to find a current equivalent that will hold up more than 2 or 3 years.

    Also, after reading this post I will think twice before believing all the nonsense Dave Ramsey spouts about the stock market returning 12% a year on average (sometimes he claims you can fairly easily surpass this rate of return by investing in well-managed mutual funds). Judging by the return of the S&P 500 over from 1950 to the end of 2007 his estimate is only high by 4 or 5 percentage points.

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