What is “normal” in stock market returns?

David Christianson, CFP, R.F.P., TEP

Remember that “stocks” means the same thing as shares, equities or equity mutual funds. We used returns for the Toronto Stock Exchange, as represented by the S&P/TSX Composite Index and its predecessors, recognized benchmarks representing Canadian stock price movements. The sources are Standard & Poors and Bloomberg.

The returns include reinvestment of dividends paid on these shares, which is an important component of total return. If you own shares and spend your dividends each year rather than reinvesting them, you will not enjoy the same high returns.

Here is a summary of what I believe:

Stock market returns vary greatly from year to year;
In the long run (most 5-year and almost all 10-year periods), stocks outperform bonds and treasury bills;
Stock prices fluctuate significantly in the shorter term, as you know, so there is substantial capital risk if you invest for short periods of time.
When the stock market has just had a terrible year (and everyone is predicting lower returns going forward), you will earn more in the next five years than if the market has just gone up for two or three years in a row (when everyone is predicting continued happy days). How ‘bout that?

Here are some specific numbers about past returns. Remember that past returns do not guarantee future returns. However, I think you will see a long term pattern developing here.

The latest data, to September 30, 2009, shows the following annualized total returns on the TSX for the past 5, 10, 20 and 30 years:

5 years = 8.34%
10 years = 7.27%
20 years = 7.93%
30 years = 9.46%

The five-year number is a surprise to many people after the year we had in 2008, but there were three excellent years before that.

To illustrate the variation in the short term, the one-year return to September 30 was zero (better than most people would expect), but the one-year return to August 30, 2009 was negative 27.7%. The negative effect of the 2008 crash is already dissipating.

The best one-year return in the last 30 years was 79% in 1982/1983. There was a gain of 51% in the year ending September 2000. Both came after bad markets, with the one-year return to June 30, 1982 being the worst in the last 30, at negative 42%.

That’s why we don’t go into the stock market with money we want to cash in for next winter’s vacation, do we ladies and gentlemen? The patterns also teach us that the extraordinary returns always come on the rebound, when virtually all hope has been abandoned.

I thank my colleagues Sam Pelletieri and Graeme Hay of Wellington West Asset Management Inc. for compiling these numbers and some interesting statistics, like this one:

On average, the one-year return on the TSX has been 7.68%. However, the “90% confidence interval” has been from minus 25.71% to plus 41.06%. That means that 90% of the time, one year returns will fall in that range. That’s a huge range, and, as I mentioned above, the range can be even greater.

The lesson? Stock market returns can vary widely over the short term. Over five-year and ten-year periods, the range of returns is much tighter and more predictable.

So remember folks – this is where your long-term money goes, not the renovation fund or cash reserves.

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David Christianson is a fee-only financial planner and investment counsel with Wellington West Total Wealth Management Inc.