At Vanguard, we believe that stocks are a primary driver of your portfolio’s growth over time. That principle holds in any interest rate or growth environment. U.S. stocks recorded an average annual return of about 10% (including reinvested dividends) through August 31, 2016, as measured by the S&P 90, from 1926 to 1957, and the S&P 500, thereafter. Comparatively, bonds returned about 5.5%, and cash returned about 3.5%, over the same time period.1

Over the past 90 years, stocks have also suffered through long and difficult periods, including the 1929 stock market crash and subsequent Great Depression. More recently, stocks waded through the bursting of the dotcom bubble in 2000, and the global financial crisis in 2008–09. In one particularly painful decade, from February 28, 1999, to February 28, 2009, the S&P 500’s annual return was –3.4% (including reinvested dividends).

As the boilerplate disclaimer cautions, however, past returns aren’t a guarantee—or even a predictor—of future returns.

Profits and returns

The case for holding stocks ultimately comes down to an expectation that companies will continue to generate profits over the long term, and that the price investors pay for a claim on those profits will be reasonable. Shareholders expect their companies to produce earnings growth, which is collected in the form of dividends, or capital appreciation.

Over time, some companies can experience difficulties, with some even going out of business. Stock prices are bid up or down as investors speculate which companies will earn or lose money. Markets are constantly reflecting investors’ latest thinking and views on companies’ prospects.

“The earnings power of companies has grown over time, but there are negatives if you zoom in on particular moments,” said Vanguard Junior Economist Matthew Tufano. “We don’t know how companies are performing in real time, and the market debates their worth. That’s why prices jump around.”

Considering valuations

Vanguard’s 2016 globaleconomic and investment outlook, which was released in December 2015, projects the central tendency for stock returns over the next decade to be in the 6%–8% range.

That’s somewhat below the historical average and is driven in part by our views on valuations, such as the price/earnings ratio. (This ratio reflects the price individuals are willing to pay for $1 of a company’s earnings.) Lower expectations for inflation and growth also temper our views on stock returns in the future.

“Shifts in valuations tend to explain the majority of stock return volatility over long periods of time,” Tufano said. “Trying to predict valuations is very, very difficult. To try and pinpoint an expected return is difficult. That’s why our return projections are focused on a distributional framework.”

Speculation influences stock market returns over shorter periods of time, while corporate profits drive returns in the long term.

Risks and rewards

A concept known as the equity risk premium explains why stocks have been so resilient and why they’ve trumped bonds and cash reserves over long periods of time. Higher expected returns are the potential reward to investors for weathering the market’s turbulence and uncertainty. In other words, investors, logically, would not hold a risky asset without being compensated. The equity risk premium is the amount of return equities provided over and above that of less-risky assets. By its very nature, however, this phenomenon does not hold in all time periods.

As John Ameriks, the leader of Vanguard Quantitative Equity Group, has written, “The equity risk premium exists on average precisely—and only—because it doesn’t exist in all circumstances. In other words, no matter what the time frame, there is a risk of underperformance (and, potentially, dramatic underperformance). It’s a ‘risk premium,’ not a ‘return premium.'”

Stocks and the economy

Although Vanguard research points to a low correlation between economic growth and stock returns, the economy and the financial markets are inextricably linked. Corporate profits are rooted in the productivity, growth, consumption decisions, and myriad other factors related to the U.S. economy and its participants. That said, forecasting stock returns is clearly not as easy as plugging in an estimate for growth.

“Corporate profits can come from cost-cutting, new technologies,” Tufano said. “Earnings can come from overseas, from increasing market share, from price pressures. And that is before you need to take into account the changing price people would be willing to pay for those earnings.”

What’s the best guidance for investors as they consider stocks? Understand that uncertainty will always be part of the equation when investing in the stock market.

“We don’t know how much companies will earn at any given point in time, but participating in those profits remains one of the most powerful ways for investors to achieve their long-term goals,” Tufano said. “The pursuit of profits is what drives companies forward, and that should ultimately create returns for investors patient enough to assume risk and invest broadly for long time periods.”

 Sources: U.S. stocks: Standard & Poor’s 90 from 1926 to March 3, 1957; the Standard & Poor’s 500 Index thereafter. U.S. bonds: Standard & Poor’s High Grade Corporate Index from 1926 to 1968, the Citigroup High Grade Index from 1969 to 1972, the Lehman U.S. Long Credit Aa Index 1973 to 1975 and the Barclays Capital U.S. Aggregate Bond Index thereafter. U.S. cash: For U.S. cash reserve returns, we use the Ibbotson U.S 30-Day Treasury Bill Index from 1926 to 1977, and the Citigroup 3-Month Treasury Bill Index thereafter.


All investing is subject to risk, including the possible loss of the money you invest.