Jinn of Quality and Risk

The US stock market has been said to have a historical 12% annual return. This rate is often used to help plan for pension funding, retirement planning, and more generally as a benchmark for investment and savings decisions. A reader from Japan asks where that number comes from, looking for a reference. Good question! The 12% figure is a nominal (arithmetic) average annual return as recorded for the broader US stock market (S&P 500) between 1926 and today. The compounded return is 10.7%; this is a more useful number to use, but the 12% rate is somewhat easier to plug into quick mental computation. For instance, the 12% rate compounded over 6 years roughly doubles your initial investment; a 10.7% rate has a 7-year doubling period.

Professor Roger G. Ibbotson (Practice of Finance, Yale School of Management) is a frequently cited source on historical stock market returns, e.g.: The compound average annual nominal rate of return (including inflation) for common stocks was 10.7 percent over the period 1926-2001. This return exceeded long-term U.S. Treasury yields by over 5 percent per year. [Note: this refers to returns on the S&P 500 Index in nominal terms --not in real (inflation-adjusted) terms.] The following paper has a detailed treatment of equity returns and causal factors -- Stock Market Returns in the Long Run: Participating in the Real Economy (Ibbotson and Chen, 2002): We decompose the 1926-2000 historical equity returns into supply factors including inflation, earnings, dividends, price to earnings ratio, dividend payout ratio, book value, return on equity, and GDP per capita. ... The historical equity return and earnings data used in this study are obtained from Wilson and Jones (2002) [Wilson, Jack W. and Charles P. Jones. An Analysis of the S&P 500 Index and Cowles' Extensions: Price Indexes and Stock Returns, 1870-1999, Journal of Business 75-3, July 2002.]. The average compounded annual return for stock market over the period 1926-2000 is 10.70%. The arithmetic annual average return is 12.56% and the standard deviation is 19.67%. Note that Business Week (2002-Apr-15) mentions an average real annual 7% return--i.e. adjusted for inflation--but without citing source or reference: Since 1982, the total inflation-adjusted return on stocks (including dividends and capital gains) has been about 12% annually. Historically, the real annual return on common stocks has averaged 7%. Since stock prices are set both by profits and by expectations of what other investors will pay for stocks, annual returns can exceed the 7% norm for years and even decades--but not indefinitely. Yale University economist Robert J. Shiller has called this a "naturally occurring Ponzi process." As Shiller has noted, stock prices also can underperform the economy for long periods. Between January, 1966, and January, 1986, annual total returns to stockholders averaged just 1.9%. There's more from Business Week (2000-Sep-08): a review of the economic literature related to long-term returns seems to suggest that a nominal 9% to 12% return is a reasonable assumption, or a 6% to 9% return after taking inflation into account. ... [Ibbotson] forecasts a nominal median return of 11.6% for large-capitalization stocks between 1999 and 2025 [and 12.5% for small-cap stocks]. (His inflation forecast over that same time period is 3.1%.)

Of course, such analysis will not predict the stock market return this year or next, but it does give us an educated guess of what trend to expect. The stock market tends to reflect the average rate of profit. If it spends much time above or below that average, we know with certainty that, in a frame of 10-30 years, there must and will be a correction in the opposite direction. Note that I refer to the real rate of profit, which can be difficult to measure, most notably in periods of inflation caused by government intervention.

Some high-level number-crunching for the NASDAQ composite (with comparatively low dividends overall, so we ignore those in the returns): 1971 at 111, 1981 at 212 (about 8% annual return), 1991 at 491 (almost 8%), 1997 at 1441 (over 10%), 2000 at 3817 (13%), and 2003 at 1509 (down to 8.5% return since 1971). [All values rounded on May-06 except 2000-May-05] If the Nasdaq had grown at a regular, compounded 10.7% from its all-time low close of 55 in October 1974, it would be at a mere 1005 today. Hmmm. Also, a Motley Fool article (dated 2000-Nov-27) had an interesting examination of where the Nasdaq would have been at the time, had it steadily returned 12% from various "magical" levels.

See also: Hybrid cars are not economical (2002-Nov-26)
Inert venture capital (2002-Nov-15) 

The first country to issue postage stamps was the United Kingdom, on May 6, 1840. On this date the Penny Post was inaugurated, with the so called "Penny Black" stamp featuring a profile of Queen Victoria. This stamp marked radical innovation on the part of the British Post Office: the payment for postage was transferred from the receiver to the sender of the letter, and a flat rate applied to letters sent anywhere in Britain (up to a half-ounce in weight, regardless of distance). This innovation embodied the quest for progress and economies of scale made possible by the Industrial Revolution.

Prior to 1840, postage rates for delivery of letters in the U.K. depended on the distance traveled and the number of sheets of paper used. Further, the postage was required to be paid by the receiver rather than the sender of the message - there was no system for the prepayment of postage prior to mailing. Since postal rates at that time were quite expensive, many people refused to accept delivery of letters. In 1837, the U.K. Postmaster General, Sir Rowland Hill, proposed a number of reforms to the domestic postal system...

In Praise of the Penny Black: The product of an industrial technology new to the 19th century, the stamp nevertheless conveys the sense of tradition, probity, and decorum we often associate with the Victorian Age.

A peculiarity of UK stamps is that they do not bear the country's name but feature the profile of the current reigning monarch instead.