Modern stock market performance reporting began in 1926, although the S&P 500 index did not exist at that time. Data from 1926 for U.S. government bonds with 20-year maturities is available, allowing for a thorough analysis of stock and bond investment performance since 1934. By studying historical data, investors can gain insight into future market trends and the variability of returns.
Calculating average returns is crucial in understanding investment performance. The arithmetic average simply adds up monthly, quarterly, or annual returns and divides by the number of periods, while the geometric average compounds the total return over the study period. The geometric average is more precise and provides a more accurate representation of investment growth. Stock returns tend to exceed bond returns over time due to the compounding effect of longer investments.
Inflation adjustments play a significant role in comparing nominal and real returns. Real returns, adjusted for inflation, reveal a considerable impact on investment performance. The reduction in real bond returns is much larger than that of stocks when inflation is taken into account. While nominal returns may seem impressive, the true purchasing power of an investment may not be as significant when inflation is factored in.
Investing $100 in 1934 would have yielded different results in today’s value and purchasing power. A $100 stock investment would have grown to $1.2 million in current value, but only $51,611 in purchasing power from 1934. The story for bonds is similar, with a $100 investment growing to $9,493 today, but only worth $408 in 1934 purchasing power. Real returns, adjusted for inflation, reveal the true growth of an investment and its purchasing power over time.
Real returns are significantly lower than reported returns in dollar terms for both stocks and bonds. The overall return advantage of stocks over bonds is much more significant in purchasing power terms than in dollar terms. Understanding the impact of inflation on investment returns is crucial in making informed decisions about portfolio allocation and investment strategies. In future articles, the correlation of stock and bond returns, as well as the effect of inflation on investment performance, will be explored further.
