Long-term market averages are mathematically accurate but practically useless for predicting what an investor will experience in any given year.
The Illusion of the Average
In the world of investing, performance is always relative. We measure active managers against indices and evaluate our portfolios against historical benchmarks to see if we are on track. For those holding low-cost index funds, the goal is simple: capture the market return net of fees. However, understanding what that market return actually looks like is one of the most misunderstood aspects of finance. There is a wide gulf between the mathematical average of the stock market and the lived experience of the person invested in it.
When we look at the long-term data, the numbers are remarkably consistent. According to the Credit Suisse Global Investment Returns Yearbook, which tracks 118 years of data across 23 countries, the global real equity return has been approximately 5.2% per year. This figure is particularly robust because it includes the total loss of capital in markets like Russia in 1917 and China in 1949. Even with the complete collapse of major markets, the global engine of capitalism has reliably produced a return of 5% above inflation over the very long run.
The Volatility of the Short Term
The challenge for the individual investor is that these long-term figures tell us almost nothing about what to expect in a given year, or even a given decade. While a 5% real return is the historical anchor, it is rarely the reality on a year-to-year basis. In a 47-year sample of Canadian, US, and International markets, the 'average' return was earned in exactly zero of those years. If we define a 'normal' year as one where returns fall between 3% and 10%, we find that the majority of annual returns fall outside that range. In fact, most years are either significantly better or significantly worse than the average.
This dispersion is why 10 years is often an insufficient timeframe for equity investing. In the United States, stocks have underperformed Treasury bills in 15% of all rolling 10-year periods since 1926. For an investor with a specific retirement date, a decade feels like an eternity, but in the context of market history, it is a blink of an eye. Investors are frequently myopic, checking their portfolios annually or even daily, but the data suggests that 'extreme' returns—those below -8% or above 15%—are actually quite common and should be expected as part of a healthy market cycle.
The Cost of Anticipation
Because the market is so volatile, the temptation to avoid the downside is overwhelming. However, attempting to time the market is historically a recipe for underperformance. As Peter Lynch famously noted, far more money has been lost by investors preparing for corrections or trying to anticipate them than has been lost in the corrections themselves. When the market crashes, the instinct is to flee to safety, but there is no evidence that avoiding the downside leads to better long-term outcomes. On the contrary, missing just a few of the market's best days—which often follow the worst days—can permanently stunt a portfolio's growth.
The practical implication is that an investor must choose an asset allocation they can live with during a worst-case scenario. This means acknowledging that the future could hold downturns more severe than anything witnessed in our lifetimes. The goal is not to predict when the next crash will happen, but to build a portfolio robust enough to survive it without forcing a sale. Staying invested regardless of the headlines is the only reliable way to capture the long-term risk premium that stocks offer.
Estimating the Future
While we cannot predict annual returns, we must still form expectations to build a financial plan. How much you save and when you retire depends entirely on your assumed rate of return. To do this reasonably, we look at two primary inputs. First, we consider the equilibrium cost of capital—the historical real return of an asset class over the last 50 years. This provides a stable baseline for the equity risk premium. Second, we must account for current valuations. Research shows a clear relationship between high current valuations and lower future returns.
To refine these expectations, we use metrics like the Shiller CAPE ratio, which compares current prices to ten-year trailing earnings adjusted for inflation. If valuations are high, we should temper our expectations for the coming years. By averaging long-term historical premiums with these valuation-based estimates, we arrive at a figure that is both grounded in history and sensitive to current market conditions. This balanced approach provides a stable target for financial planning while acknowledging that the market's path to that target will be anything but a straight line.