The S&P 500 has done roughly 10% average total return since inception. 3% of that number is due to the CPI which is a very poor measure of actual inflation and probably understates real inflation by half. Here is an example.
The single largest component of the CPI is housing. But it doesn't measure the cost of homes but rather "owner's equivalent rent" what a home owner would charge to rent their home. There are several problems with this method, first being someone who is not in the rental market probably has little knowledge of what rents are.
Second problem is that interest rates themselves create a feedback loop in the reporting of inflation with such a measure. Someone who has a low interest mortgage would more likely think they would charge a lower rent since their debt service payments would be lower, when in fact the value of homes would be higher for the same reason.
But let's stick with the 7% number from above. Now let's deduct an additional 25% for taxes (1.75%). You're at 5.25%.
Let's now figure in volatility. What you say? The S&P has averaged 10%, we all know that. But what you probably do not know is how volatility affects actual returns.
Take this example.
You start with $100and invest in the S&P500. In year one you make 20%! In year two you make 10%! In year 3 you lose -20%
, in year 4 make 10% and year 5 make 10%. I think you will agree that the average return over that 5yr period is 6% (20+10-20+10+10)/5 = 6At the end of that 5 year period you would have $127.78 before taxes and any expenses.
Now if you took that same $100 and made 6% every year for 5 year you would end up with $127.78 right?
Wrong.
You would have $133.82 or 21% more growth. Use that same math over longer periods of time and the difference becomes far greater. I've done the calculation for the S&P going back long periods and that 10% average return really equates to a real rate of return much closer to 7%.
Now subtract taxes, inflation, expenses and if you make a real rate of 2-3% you should be fairly happy.
And I haven't even gotten to the parts about market timing and the low interest rate/debt fueled growth in equity markets. I personally don't believe those conditions can last forever, but maybe they can. it would be highly unusual however.
.
