Relying on the exceptional performance of the 20th-century U.S. stock market leads to flawed financial planning and unrealistic expectations.
The Origin of the 10% Myth
It is a common refrain in personal finance: the stock market returns 10% on average. At first glance, the data seems to support this. From 1950 through 2023, U.S. stocks delivered a nominal annualized return of 11.32%. Even looking at the last twenty years, the total U.S. market returned nearly 9.8%. For an investor looking primarily at recent American history, the 10% figure feels like a law of nature. However, this belief is misguided and can lead to significant errors in financial planning, such as undersaving for retirement or miscalculating the trade-off between investing and paying off debt.
The first step in debunking this myth is distinguishing between nominal and real returns. Nominal returns do not put food on the table; real returns, which account for inflation, do. For example, in the 15 years ending in 1985, the U.S. stock market returned a seemingly robust 10.58% annually. Yet, inflation ran at 7.05% during that same period, eroding the vast majority of those gains. When we adjust for inflation, the 'exceptional' post-1950 era actually yielded a real return of about 7.6%. While impressive, even this figure is an outlier when compared to the broader sweep of financial history.
The Gravity of Valuations
To understand why the 7% real return of the last seventy years is unlikely to persist, we must look at what drove it. A substantial portion of that performance was fueled by rising valuations—investors becoming willing to pay more for each dollar of earnings. In financial markets, valuations act as a weak form of gravity. When valuations rise, they pull past returns upward, but they simultaneously push expected future returns downward. High prices today mean we are paying more for future cash flows, which inherently lowers the expected yield on those investments.
Economists Eugene Fama and Ken French explored this in a landmark 2002 paper. They found that between 1872 and 1950, realized stock returns were very close to what could be expected based on dividends and earnings growth. However, from 1951 to 2000, the realized risk premium was nearly three times higher than their estimates. This suggests that the latter half of the 20th century delivered 'unexpected' returns driven by falling discount rates. Because we cannot count on valuations to rise indefinitely—especially when they are currently in the 97th percentile of historical expensiveness—we cannot use that 7% real return as a baseline for the future.
The Luck of the Survivor
Beyond valuations, the U.S. market has benefited from what researchers call survivorship bias. Over the last century, the United States has been remarkably lucky. It avoided the total market collapses, hyperinflation, and geopolitical disasters that decimated the wealth of investors in many other nations. As the world learned that the U.S. was a safe haven, the 'discount rate' applied to U.S. stocks dropped, further driving up prices. This 'learning' and good luck account for roughly 2% of the historical U.S. equity risk premium.
When you strip away the 2% return attributed to luck and the expansion of multiples, the real return on U.S. stocks drops to approximately 5.28%. This figure is much more consistent with the pre-1950 U.S. experience and, crucially, with the experience of the rest of the world. Global real stock returns from 1900 to 2023, excluding the U.S., sit at 4.35%. By focusing only on the most successful market during its most successful century, investors are essentially looking through a rearview mirror and assuming the road ahead will be paved with gold.
A More Realistic Forecast
If the 10% nominal (or 7% real) return is a mirage, what should a responsible investor expect? A more robust approach involves starting with global historical data, removing the returns attributed to past valuation changes, and then adjusting for today’s high starting prices. When we apply this methodology, the expected real return for a diversified global equity portfolio is closer to 4.6%. If we assume a target inflation rate of 2.5%, this results in a nominal return of roughly 7.2% before fees.
The difference between a 10% return and a 7% return may seem marginal, but the power of compounding makes it transformative. Over a thirty-year career, that 3% gap can mean the difference between a comfortable retirement and a significant shortfall. It changes the math on whether you should prioritize a mortgage payoff or a brokerage account. Stocks remain the best engine for long-term wealth creation, and they are still expected to outperform bonds. However, by grounding our expectations in global reality rather than American exceptionalism, we can build financial plans that are actually built to last.