Stocks have been long considered a staple in the portfolio of the average investor.  Through purchases of individual stocks, as well as funds through 401(k) and other retirement vehicles, a significant number of investors are counting on the markets to make money for them.  The idea is that when comparing stocks and inflation, equities would provide returns that can outpace increases in the cost of daily living.

Certainly, the market has shown the propensity to provide out-sized returns at times.  2012 and early 2013 saw very high rates of return, making investors quite happy.  The late 1990’s provided a multi-year period of strong stock returns as well, as many of us know.  There have also been numerous other individual years with very good returns – as in, well over 20%.  It’s tough to get that type of return in a conservative investment, right?

Well, stocks aren’t always money machines, like ATM machines dispensing for account holders.  Rather, they have good years and bad years – sometimes stocks lag inflation!

In the midst of a bull market, I decided to take a look at the returns of stocks, 3-month T-Bills, and compare to inflation.

Stocks and 3-Month T-Bills vs. Inflation

For this analysis, I went all the way back to 1970.  It’s possible to go back further, but I think over 40 years is a pretty good time frame.  In crunching the numbers, I used the following data:

• Stocks: S&P 500 annual open and close values
• 3-Month T-Bills: FRED (Federal Reserve Database) reported rates
• Inflation: annual percentage rate increases reported by Bureau of Labor Statistics

I then broke out the data by decades:

• 2010-2012 (3 years)
• 2000-2009 (10 years)
• 1990-1999 (10 years)
• 1980-1989 (10 years)
• 1970-1979 (10 years)

For each metric, I calculated the average, minimum, and maximum.  For example, for averages, this was based on a  sum of each year’s individual performance, divided by the number of years in the group.  To take a 2 year time period as an example, if year one had a 10% return, and year two had a 5% return, that would equal an average annual return of 7.5%.  As in, 15 divided by 2.

With that in mind, here is what I found:

2010 – 2012

During these 3 years, which are the most recent in the analysis, stocks clearly performed very well.  Here is how things went:

 

 

 

As can be seen, treasury bills haven’t returned much.  Inflation has been higher! Of course, inflation has also been low, which puts those returns in perspective as being remarkably low.  Stocks have done quite well by comparison, easily outpacing inflation.  This isn’t even including the increases in 2013, which would further reinforce this point.

Clearly, people who have owned stocks have seen their investments make money for them, relative to low-risk alternatives and in comparison to inflation.  Stocks have generated wealth in the early part of this decade!

This, I think, is what many folks might be focusing on. It seems like the recency bias can impact investors to high degree.   It’s almost as if this is the way markets are supposed to perform – or so we would hope!

2000 – 2009

Things look different when we go back to the past decade:

 

 

 

There were a few really bad stretches for stocks during this time period.  2008 was atrocious, as many of us remember how gloomy it was for investors then.  Annual declines were well over 30%.  2000 to 2002 were bad years as well, as the market retracted each year.  Of course, there were good years mixed in too, but overall it was kind of a silent decade for stocks on balance.

Meanwhile, one could have done better in other investments.  In many markets, the early 2000’s saw unreal returns in real estate, though some of that was given back toward the end of the decade.  Simply keeping pace with inflation would have been good for those investing in equities.  Stocks trailed inflation for the decade!

1990 – 1999

During this decade, stocks performed quite well.  Much of this benefit came during the back half of the 90’s, as 1996 to 1999 saw mega-sized returns during a prolonged bull market.  A lot of people got wealthy during this time, and the smart (or lucky?) ones that cashed out before the millennium actually got to convert the paper gains into real wealth.

 

 

 

Note that inflation was higher, but 3-month T-bills provided solid returns, compared to what has been seen in recent years!

1980 – 1989

Going back another decade, this was another good one for stocks.  What jumps out at me are the 3-month T-bill returns, which were clearly quite high during a part of this decade.  In 1981, in particular, this brought over 14%, while stocks declined nearly 10%!

 

 

 

Check out inflation, which was quite high in the early 1980’s, reaching double digits for a while.  Clearly, the current low rates of inflation pale in comparison to what we have seen in the past!

1970 – 1979

Here, we see that stocks actually had kind of a rough decade, all things considered.  There were some good years, but some bad ones as well which impacted the decade.  1973 and 1974 were particularly tough years.

 

 

 

Neither stocks nor T-Bills outpaced inflation during the 1970s.  If people talk about the first decade in the 21st century as being a lost one, how about the 1970’s? The era when people spent money on disco fashion and avocado-green bathtubs was also one where on average they weren’t seeing enough money being generated through stocks.

Overall: 1970 – 2012

When taken together, this decade currently in progress and the four prior combine to paint an interesting picture.  On average, stocks have provided a rate of return higher than inflation and supposedly “risk-free” investments.

 

 

 

The thing is, however, these returns are not that much greater.  Clearly, there is only a modest difference over this 43-year period between stocks, T-bills, and inflation.

Stocks and Risk Premiums

Take a look at that modest benefit to stocks, in terms of differential in returns.  Just a few percentage points, that’s it.  On the other hand, there is significant volatility in stocks, as we can see by the staggering max and min of the annual returns within each decade and overall.  Thus, there has only been a minimal equity risk premium to stocks over this time period.

That premium has been enough for people to make money, obviously.  Every percentage point counts, and rate of return is important.  Stocks, on average, haven’t been bad investments.

However, we should also keep in mind these points:

• There is no guarantee that stocks will be great investments.  I think that’s important for people to remember, especially when during bull markets or other periods of good stock returns.
• Inflation isn’t always insignificant, and recent years have been quite unusual.  It simply takes looking at past decades to show that there have been times when the cost of living soared while stock markets declined, so things can go the other way.

Bottom Line: Stocks can be great, and it’s easy to be intoxicated with confidence about the markets and their ability to make us money.  But they’re no guarantee of success, depending on your time frame.  Realism is vital, and so is diversification!

My Questions for You

When thinking about stocks, do expect them to have a rate of return greater than that of inflation?

Do you think that many people can be overconfident in stocks, overlooking historical considerations?

What do you think about the risk premium for stocks, based on the difference in return of stocks versus other less risky vehicles?