The truth is, it’s realistic to achieve a 12% annual return over the long run.
There are lots ETFs (exchange-traded funds) and mutual funds out there that have averaged 12% annual returns over time.
You just need to do some homework and find them.
But before we go there, let’s go over some of the basics about the stock market and its historical average returns.
Where Does a 12% Average Return Come From?
When I say you’re able to make a 12% return on your investments, I’m using real data that’s based on the historical average annual return of the S&P 500.
The S&P 500 is an index that tracks the performance of some of the 500 largest publicly traded companies in the United States. It’s also regarded as the most popular and well-known gauge of the U.S. stock market, making up around 80% of the total U.S. public market capitalization.
The S&P 500’s historical average annual return from 1928 through 2021 is 11.82%. 1928 was a long time ago, so most people now weren’t around during that period.
So let’s look at some numbers that are more recent, and spanning over 30-year time periods:
- 1990 to 2020: S&P’s average was 11.55%
- 1985 to 2015: S&P’s average was 12.36%
- 1980 to 2010: S&P’s average was 12.71%
Keep in mind, these are the returns spread out over 30 years. When you zoom in and look at the year-to-year returns, you’ll see the annual returns vary and the stock market can appear risky on the surface.
In 2015, the market’s annual return was 1.38%. But look back to 2013 and you’ll find the market returned 32.15%. Even looking at a wild year such as 2020 with the onset of the pandemic, the S&P 500 ended up delivering a return of 18.02%. This is why you shouldn’t get caught up in what happens in any given year. As an investor, you have to be ready for the now and then off or bad years and also the great years.
Wasn’t There a“Lost Decade”?
Until 2008, every 10-year period in the S&P 500’s history had delivered overall positive returns. But from 2000 to 2009, the market saw a major terrorist attack and a recession.
The S&P 500 reflected those tough times with an average annual return of 1% and a period of negative returns after that, leading the media to call it the “lost decade.”
But that’s only part of the picture. In the 10-year period right before that (1990–1999) the S&P averaged 19%.
If you put the two decades together you actually get a respectable 10% average annual return.
Again, this is why you need to have a long-term view on investing instead of simply looking at the average return each year.
What About Future Returns?
In investing, we can only base our expectations going forward, based on how the market behaved in the past. And the past shows us that each 10-year period of low returns has been followed by a 10-year period of excellent returns, ranging from 13% to 18%.
Will your investments make as much as the S&P 500?
It may. Or it may not.
Or it may return even more.
One thing for certain, is that no one knows for sure, not even the experts on Wall Street, and definitely not Jim Cramer.
It’s About Your Savings Rate
Studies have shown that the single most important factor when it comes to retirement success isn’t investing in funds with the highest rate of return, how your investments are divided, or what your investment fees are.
Yes, those things matter.
But it’s your savings rate — the fact that you’re actually putting money into your 401(k) and IRA every month — that is most likely to help you in reaching a successful retirement.
In other words, it doesn’t matter what the average annual rate of return is if you don’t invest anything at all.
So my advice is, if you want to have money in retirement, then start putting away money into your 401(k) and IRA.
In fact, how much and how often you save for retirement is 45 times more important than picking and choosing what to invest in.
Yet, there are always financial “experts” that want you to believe that seeking out funds with a few basis points in lower fees is what you should care most about (one basis point is 0.01 or one-hundredth of one percent — so 100 basis points equals 1%).
Let’s say you invested 15% of a $50,000 salary from age 25 to 65, and assume you get a 12% average annual rate of return. Take a guess what your investment balance would be you would by the time you retire at 65.
$7 million.
And that’s assuming you don’t get a single raise over the course of your entire lifetime (which I hope for you that is unlikely)!
But just to play devil’s advocate, let’s say I was too optimistic. Let’s instead assume you invested that same amount, but you only got a 6% annual rate of return.
What would your investment balance be at 65?
You’d still end up a millionaire with $1.2 million in your nest egg.
How to Invest in ETFs or Funds
When you’re ready to invest, target to invest 15% of your gross income in tax-advantaged retirement accounts. If your company offers a 401(k) enroll and make regular contributions, even if they don’t make matching contributions (although many companies do).
When you start looking at ETFs or funds, be sure to diversify your investments. I recommend splitting up your investments equally into four categories:
- Growth
- Aggressive Growth
- Growth and Income
- International
Do your research and look for ETFs or funds that average or exceed a 12% long-term average return. You’ll see it’s not that hard to find a good number of them to pick from.
One caveat — I’d stay away from any Cathie Wood ARK funds. These funds have high fees and have largely delivered losses on a consistent basis to investors. Although I give her an A for being a good marketer.
Final Thoughts
What you should care about is how your investments perform over the span of many years.
And based on the history of the market, a 12% return is not some magic number. 12% is actually a reasonable return as long as you have a long-term time horizon.
