Average Investor Returns

Money (Sept. 2004; pgs. 83-87) has an article that discusses the market returns that the average investor has gotten. Ilia Dichev of the University of Michigan found that the New York stock exchange and the American stock exchange investors returns lagged market returns by 1.3% between the years of 1926-2002. Nasdaq investors lagged the market return by 5.3% from 1973-2002.

Jason Zweig of Money magazine and three other finance experts performed study in 2002. They watched the money moving in and out of 6,900 U.S. stock funds between 1998-2001. They found that the average fund returned 5.7%, while the average investor only earned 1% due to poor timing.

Historically stocks have outperformed inflation over all holding periods of at least 20 years. Bonds have underperformed inflation over long stretches, but can outperform inflation over shorter terms. Unfortunately only three other stock markets have outperformed inflation over similar terms.

John Bogle, founder of Vanguard funds, says that stock gains come from two sources: the "investment return" (dividends plus earnings growth) and "speculative return" (how eagerly investors bid stocks up, or down, over time).

Dividends have plummeted from a 4.3% average to 1.7%. This wouldn't be bad if the money was invested in growing the business. Unfortunately this money in invested in buying other companies, or to cover stock options granted. This doesn't help the companies. Earnings growth has averaged 2% annually, over inflation. If you add in the current average dividend yield, returns are only around 3.5%-4%.

The price to earnings (PE) ratio of stocks started the 20th century around 13.5. They rose from a low of 8 in 1982 to 33 in 2000. Stocks now trade around a PE ratio of 20.

Only three markets in three countries have posted better inflation adjusted returns than the U.S. in the past century. More than half the world's stocks are traded outside the U.S. Money feels that at least 25% of your portfolio should be in foreign stocks as a hedge against local market calamities.

Finally they recommend making sure you have human capital (good career and education), physical capital (your house and other possessions), and financial capital (stocks, bonds, and cash). You can hedge your resks by picking up new job skills, buying a second home elsewhere, and diversify your investments.