As I'm building this portfolio I do need to have some expectations for the future. Something to keep me motivated throughout the years of this journey. To some extent my portfolio will follow the market, and I've therefore established some estimates for the long term return in the market. And to do so I've looked to the past.


In an efficient market prices are believed to move independent from the past. However, I have no better estimate for the future than the long term returns we have seen in the past.

Although my portfolio does not consist of any stocks given in the S&P 500 index, I have chosen this as the market proxy. One could argue that I should find a better proxy for my market, but lets talk about that in a later post.


Year Price
1950 17.22
1960 55.61
1970 85.02
1980 114.16
1990 329.07
2000 1,394.45
2010 1,073.86
2017 2,278.87

The table to the left shows the price of the S&P 500 index at January 1st the given year. The data is retrieved from Yahoo Finance.

A quick glance at the table might cause one to think that these are great returns, since an increase from $17.22 in 1950 to $2,278.87 in 2017 is a 13,133% return.

But we need to know the annual return of the market, and for this we can use the Compound annual growth rate (CAGR) formula.


I have calculated the CAGR of S&P 500 for different time periods from 1950 to 2017, illustrated in the matrix below. The highlighted cells are commented below.

1950 1960 1970 1980 1990 2000 2010
1960 12.44%
1970 8.31% 4.34%
1980 6.51% 3.66% 2.99%
1990 7.65% 6.11% 7.00% 11.17%
2000 9.19% 8.39% 9.77% 13.33% 15.53%
2010 7.13% 6.10% 6.55% 7.76% 6.09% −2.58%
2017 7.56% 6.73% 7.25% 8.43% 7.43% 2.93% 11.35%


Note that the above rates are not adjusted for inflation. The Norwegian Government has an inflation target of 2.5% per annum, which I need to take into account when considering my purchasing power.

Following the first diagonal you see the returns over a 10 year period, which varies from a high 15.53% to a low -2.58%. As you increase the holding period (next diagonal), you can see that the annual stock returns are more stable. For example a 30 year holding period varies only from a high 9.77% to a low 6.11% per annum.

Note that the CAGR from 2000 - 2010 is actually negative, which is explained by the financial crisis we had late in that period. But even when you include the bull market we've had after 2010, with a CAGR of 11.35%, you only end up with a annual growth rate of 2.93%. Just slightly above the inflation target of my home country.

Following the argument of more stable returns over longer holding periods I've ended up with the CAGR of 1950 - 2017 for my expectations, which is found to be 7.56%. This is a holding period of 67 years, which may be way to long for my lifetime, but shortening the period of 10 - 20 years does not alter the CAGR much.

To summarise I think it's sensible to expect a long term return of 7.5% for my portfolio. With an inflation target of 2.5% I end up increasing my purchasing power with 5% per annum. This is no way to get rich fast, but stead and slowly will do it for me.

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ATMahan
September 5th, 2017 20:28

The Beta Post,

For your benefit I offer real life data (mine):

I have been calculating the CAGR on my retirement savings every January 1st since I started investing in 1998. My investment strategy has been similar to the one you are now embarking on. In my case, contributions and company matches into a life-cycle mutual fund. As of January 1, 2017, my CAGR was 7.21932%, close to what you are calculating.

Here are what my CAGRs have calculated at every year:

1998 14.0429925.45035 006.75787 01 -4.405 02 -7.44179 033.35954 046.54761 056.85746 067.99058 078.01448 08 -3.10748 092.38270 104.46717 112.89319 124.46717 136.48922 146.53762 155.5794 167.21932%

If you plot this, it will look like a stabilizing oscillation with large fluctuations at first, then smaller ones later.

My kids college savings show similar behavior (though of course they occur within the same period and in the same market).

I am of the opinion that the longer I keep investing the way I am (beyond 20 years) the more precise an expected CAGR range can be derived, regardless of impact of bull/bear markets. In other words, the more stable it becomes.

But we will see in the next major downturn if this is correct.

I hope this helps/gives you confidence, in your expectations!

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The Beta Post
September 6th, 2017 16:04

Hi ATMahan, and thank you for a great comment!

Very interesting data you have there, and as you say, this builds my confidence in my expectations for the market return. I just need to continue diversifying so that my portfolio will follow the market more closely.

I do not have an exact exit date for my investments, but beyond 20 years is for sure. Around 7% should then be possible using both your calculations and my own.

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ATMahan
September 5th, 2017 20:38

wow, my annual CAGRs did not post properly. Let's try again using a different format (1998: +14.042, 1999: +25.45035, 2000: +6.75787, 2001: -4.405, 2002: -7.44179, 2003: +3.35954, 2004: +6.54761, 2005: +6.85746, 2006: +7.99058, 2007: +8.01448, 2008: -3.10748, 2009: +2.38270, 2010: +4.34021, 2011: +2.89319, 2012: +4.46717, 2013: +6.48922, 2014: +6.53762, 2015: 5.5794, 2016: +7.21932)

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Karl Steiner
September 14th, 2017 15:54

You are taking a very rationale approach to this, which is wise. There's substantial evidence that returns for stocks will be below historical averages in the next 10 to 20 years. I talk about it here and compile estimates from many different sources. http://www.mindfullyinvesting.com/articles/6-what-to-invest-in/6-2-expected-future-returns-and-risks/

The consensus right now seems to be around more like 4 to 6% total nominal return moving forward for the foreseeable future. This estimate is not inflation adjusted (i.e., nominal, not real). Of course, there are huge uncertainties with any number you may pick, which I also talk about on my website. Cheers!

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The Beta Post
September 16th, 2017 07:42

Hi Karl,

A very thorough post you have there, and your website seems like a great read, and I'll be sure to follow it!

4% to 6% total nominal return is in the range of what I expected as the real return, so this will for sure alter my expectations. I'll keep this in mind moving forward.

Thanks for commenting!

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