Modern investors have tons of data points to consider when making their moves on the stock market. One of the most pertinent is the average rate of return on stocks — how much a given commodity’s value increases on a year-to-year basis.
The stock market average return says a lot about the overall health and stability of the stock market, but it can also be a key figure in understanding your personal finances, especially as they relate to investments.
What Is The Average Stock Market Return?
What We Mean When We Talk About Average Stock Market Return
A stock market return is, simply enough, the profit an investor makes on the individual commodities within their portfolio. If you invested $175 for one share of stock in 3M (MMM) and their stock price increases to $177.50 a week later, you’ve made a stock return of 4.375% in a week.
Then what is the average stock market return? It’s a broader calculation: The average return on a series of investments over a specified time. The formula for deriving an average stock market return is to divide the overall sum of returns by the number of returns.
For example: Say General Motors (GM) has delivered the following annual returns over a five-year period:
Year 1: +4.6%
Year 2: +3.2%
Year 3: -0.5%
Year 4: +1.3%
Year 5: +3.9%
To determine the average annual stock return for GM over these five years, simply add up all of the percentages (subtracting the declines, like in Year 3 of our example) and divide the result by 5:
(4.6% + 3.2% – 0.5% + 1.3% + 3.9) = 12.5%
12.5% / 5 = 2.5%
GM’s average stock market return for that five-year period, therefore, is 2.5%.
Average Stock Market Returns in Your Portfolio
Long-time investors use average stock returns to gauge their overall progressive success in the stock market.
Most online investors have easy access to their stock investment histories, which they can use to calculate their average rates of returns quite easily.
For example: Say you’ve been an active investor for four years. You started with $3,400, and four years later, your portfolio’s value has increased to $5,100. Its value has gone up by 50% over those four years, for an annual average stock return of 12.5% on the original investment.
You’ll get the same result (or very, very close to it, depending on how you round decimals) if you add up your annual returns for each year (14% + 6% + 17% + 13% = 50%).
Another way of calculating average stock market returns in a portfolio is by using year-to-year growth figures. For example, if you start with a $2,000 investment that grows to $2,500 in Year 1, your investment returned $500 or 40% of $2,000. If that grows to $3,250 in Year 2, your annual gains were $750 ($3,250 – $2,500) or 30%. So your annual average stock market return for those two years is 35%: (40% + 30%) divided by 2.
What Does an Average Stock Return Tell Us?
The average stock return is a valuable data point for evaluating stock market success or profitability. When a company posts solid, steady returns over a long period — say, 15% — it’s a good indicator of its overall position in the marketplace. Barring unforeseeable events, it may represent a good value stock.
But average stock return can be misleading when we use it to evaluate certain kinds of companies, especially young, small- or micro-cap businesses. Oftentimes, these small companies experience a few initial years of tremendous share price growth — even 30% or higher — that reflects their expansion or increased visibility in the marketplace. But that figure may settle down to something less eye-popping the longer the company is around — perhaps annual average stock returns of only 7%.
By comparison, a large-cap, blue-chip stock — think something like Amazon, Johnson & Johnson, or McDonald’s, the market dominators that aren’t going away anytime soon — may only generate annual stock returns of 5 or 6% every year. But that doesn’t make them bad investments. Indeed, the steady, consistent gains that these companies make are attractive to people who are looking for more secure, dependable income generators to invest in.
Like every other piece of data you’ll encounter when you get heavily into investing, the average stock return is only part of the overall picture of a company’s financial status. But it’s a big one, along with revenue, net profit, cash on hand, running debt, operating costs, and other financial info. The average stock market return should be considered in the context of all of these other facts and figures.
Broader Uses of Average Stock Market Return
You can tweak the calculations of average stock market returns to see data that is more meaningful for your situation. In general usage, however, average stock market returns are weighed when you evaluate the performance of major stock market indices.
The S&P 500 and the Dow Jones Industrial Average are the most well known stock indices in the world. They’re a method that people use to analyze the overall success or failure of the stock market as a whole.
Each index follows the price movements of a specific subset of stocks. The S&P 500 measures the stock performances of the top 500 companies on the exchange, whereas the Dow Jones only focuses on the top 30.
The relative performances of the S&P 500 and the Dow Jones average are considered to be benchmarks — the ongoing snapshot of the general health of the securities markets. Investors use these benchmarks, especially the S&P 500, to determine the strength of their portfolios.
For example, if your stock values went up by 15% in the month of March, while the S&P 500 average only went up by 12%, you’re “beating the market.” The bottom line is that you’re doing well.
What is the Stock Market’s Annual Average Stock Return?
The stock market has been around in some form for a very long time. Trading shares in commodities has existed in Europe since the Middle Ages. The first U.S. stock exchanges went up shortly after the nation declared its independence. The benchmarks we just discussed — the Dow Jones and S&P 500 — were founded in 1896 and 1923, respectively.
From its inception through 2018, the Dow Jones’ annual average stock return was 5.42%. That figure represents the annual growth of the 30 biggest companies on the stock exchange. Because its scope is so limited, an off year for just one of the companies on the Dow Jones index can put an outsized dent on its overall growth.
For example, in 2020, Boeing — which is one of the Dow Jones 30 — experienced a 34% decline. That shaved 700 points off the Dow Jones’ index, resulting in an annual return of 9.7% from the benchmark in 2020, down from 22.3% the year before.
Over its nearly century-long existence, the S&P 500 has produced an annual average stock return of around 10%. That’s encouraging because S&P’s broader reach of 500 stocks is more representative of the overall securities market, which is why most modern investors prefer to track their performance against the S&P 500. In 2020, the S&P 500’s annual average stock return beat that of the Dow Jones Index, 18.4% to 9.7%.
Other indices track different arrangements of companies to get better views of a certain market structure. For example, take the Nasdaq Composite. It only tracks companies that trade on the Nasdaq Exchange, which tends to be more oriented toward technology and biotech. Lately, the Nasdaq Composite has shown a tremendous annual stock return; in 2020, it increased by a whopping 45%.
In the last 10 years, the Nasdaq Composite’s annual average stock return has been 14.39%. That says something about the nature of the companies that trade on the Nasdaq — many of them are innovators and market disruptors that are working toward future products and advanced technology solutions.
What’s a Good Annual Average Stock Market Return for an Investor?
It’s difficult to establish a baseline for acceptable annual average stock market returns for personal investors, primarily because every investor has different incentives, priorities, and portfolios. Some investors also have limited patience, making stock decisions based on immediate factors and emotional hunches, which defeats the reality of the stock market as a long-term investment tool.
Keeping in mind that one needs to actually stay in the market to generate any annual return at all, average stock market returns are statistics that are especially meaningful to those who “buy and hold.” That’s generally a good practice for most conservative investors. Active investors benefit most from a mix of dependable buy and hold stocks and a few contained growth stocks.
If you’re beating the indices regularly, then you’re doing great. If you’re looking for a more established, statistical baseline to target, many experts suggest crafting an investment portfolio with an annual average stock market return rate of 6%. That considers the real probabilities of occasional stock market declines and unforeseeable future events.
The key takeaway from examining the average rate of return on stocks is that it’s a very helpful statistic, one of the most important ones to use to determine the long-term health of economies, both public and personal.