How Great Are Those Investment Returns Really?

optical illusion

These circles are not actually rotating. Cool trick huh?

There’s a lot of advice out there promising to deliver investment returns that beat the market. In a lot of cases this advice is coming from people who claim to have gotten themselves X return over Y period of time, and of course it’s always an impressive-sounding number. The personal stories can be incredibly compelling because they make it sound like it’s just an Average Joe out there dominating the investment world, so of course you could too.

There are many reasons to be skeptical of these people. The first of which is all of the data showing how unlikely it actually is to beat the market consistently over time. The second of which is that almost all of these people have no one overseeing their proclamations, meaning you have no idea whether they’re telling the truth or whether they even know how to properly calculate their returns. The third of which is that there’s almost never a real discussion of the risk involved with their investment strategy, which may be significant.

And then there’s the question of what their reported returns are being compared to. Often it’s nothing, with their return numbers being presented in a vacuum. Without any comparison, it’s impossible to decide whether their returns are actually worthwhile, or whether they’re just following the larger market trends.

What has the market returned recently?

Before you let yourself be impressed by someone’s reported returns, it’s important to have a benchmark for comparison. That benchmark will be different depending on how that person is investing. If they’re investing only in US stocks, then the US stock market should be the benchmark. If they’re investing internationally, then some kind of international market should be the benchmark.

But for our discussion today, that kind of precision isn’t all that important. For simplicity’s sake, we’ll look at the returns over the last few years for the US stock market, the US bond market, and a mix of the two.

The purpose of this exercise is to give you something basic to compare to when you hear someone proclaiming their latest and greatest investment results.

Recent US stock market returns

I’m going to use the mutual fund VTSMX, Vanguard’s Total US Stock Market index fund, as our measure of the US stock market. Here are the returns for the past few years:

stock market returns

Returns are for VTSMX from 1/1 of the year in the “Since” column through 8/22/2013

The “Annual Return” and “Total Return” columns are just different ways of presenting your return over the period from the start of the year in the “Since” column through 8/22/2013.  The “Annual Return” column presents the average yearly return of the US stock market. The “Total Return” column shows you the total growth of your money over that same period.

Recent US bond market returns

Now we’ll look at recent US bond market returns using the mutual fund VBMFX, Vanguard’s Total US Bond Market index fund:

bond market returns

Returns are for VBMFX from 1/1 of the year in the “Since” column through 8/22/2013

Recent returns for a 50-50 stock-bond split

Now let’s look at how an investment portfolio split 50-50 between US stocks and US bonds has performed over the last few years:

50-50 stock-bond returns

Returns are for a 50-50 split between VTSMX and VBMFX from 1/1 of the year in the “Since” column through 8/22/2013

How should we use this information?

These are not perfect comparisons for all investment strategies. Nor should they set any kind of expectations for your investments going forward. But they provide a starting point for you to be able to compare someone’s reported returns to a useful benchmark. If someone started investing in 2009 and is telling you they’ve gotten 15% returns in the stock market since, that might sound great compared to the historical average of 8.92%. But when you put it next to the 17.31% that the stock market as a whole has returned since then, it suddenly isn’t as impressive.

Providing information out of context is one of the biggest problems I see with a lot of the investment advice out there. When you’re reading or listening to something, it’s important to understand not only what the person is telling you but what they’re not. My hope is that the information here gives you a little more defense against investment sales pitches in the future.

Photo courtesy of Robson#

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  • DC @ Young Adult Money August 26, 2013

    When it comes to investment returns it seems like it’s all relative. If you can get 20% why would you want to make 10%? If you can get 30% why would you want 20%? I agree, though, that you have to take everything in consideration such as risk, investment horizon, and more.

    • Matt @ momanddadmoney August 27, 2013

      I don’t think it’s all about shooting for the highest returns. But it is important to make sure that you’re doing things efficiently. Taking stock market risk without getting the full stock market returns is a losing proposition.

  • Pauline @ MakeMoneyYourWay August 26, 2013

    The rate for those past years are really impressive. But the majority of investors are in it for the long term, and not smart or lucky enough to time the market, so the long term average rate would be the one that counts.

    • Matt @ momanddadmoney August 27, 2013

      The long term rate certainly matters, but it’s not the whole picture when comparing results. Going back to my example, someone who’s returned 15% investing in the stock market since 2009 seems like they’re doing great when compared to a long-term average of 9%. But when put against the fact that the market as a whole has returned 17% in that period, it becomes clear that that person has actually been sub-par. It’s important to understand long-term trends to set expectations going forward, but to judge someone’s results over a shorter time period you need a comparison over that same shorter time period.

      • Pauline @ MakeMoneyYourWay August 27, 2013

        I guess what I really meant was if Bob is returning sub market and Jim over market, it is temporary, and chances are one is not lucky enough to switch between them and market to get the highest return all the time, so it is tricky to compare rates unless it is in retrospect.

        • Matt @ momanddadmoney August 27, 2013

          Very good point. Maybe I wasn’t clear about that here but I certainly wouldn’t suggest simply looking for the person who’s given the best returns recently and following them. That’s a recipe for trouble. My point was more to make sure to compare active investors to a relevant market over the same time period so you can get some sense of whether they actually might be adding value. I see so many people out there bragging about their great returns recently when they’re actually doing worse than the market as a whole. That’s the problem I was really trying to address.

  • Andrew August 26, 2013

    It’s true that everything is relative. Numbers can always be manipulated to make it seem like one strategy is superior to another. Salesmen are good at what they do, the sales pitch always sounds good so it’s importation to be an informed consumer.

    • Matt @ momanddadmoney August 27, 2013

      I am constantly amazed at how easily numbers can be manipulated to argue just about anything you want. Keeping yourself informed and having good objective sources of information are the best tools at your disposal.

  • Context is key. I just shake my head when friends talk about getting awesome returns and what good investors they are (since 2009). Way too reminiscent of the late 90’s – early 00’s and people’s cockiness then!

    • Matt @ momanddadmoney August 27, 2013

      Couldn’t have said it better myself. Performance without any comparison is impossible to judge. Overconfidence brewed from success investing in a bull market is a sure-fire way to get yourself in trouble down the road.

  • Clayton August 26, 2013

    The one thing most of these people forget to say is that you can’t know the future. I still invest, just only what I’m willing to lose

    • Marissa August 26, 2013

      I think they do that on purpose, Clayton. It’s one strategy of these people to get people to invest.

      • Matt @ momanddadmoney August 27, 2013

        I certainly think some people do it on purpose. Particularly people who are in the business of selling you a product or advice. But some people also do it out of ignorance. I see a lot of people writing online about their recent investment performance, and I think many of them genuinely believe that they’re exhibiting a skill that will persist over time. I personally believe that 99% of them are mistaken.

    • Matt @ momanddadmoney August 27, 2013

      Very true that the future is unpredictable and yesterday’s returns promise nothing for the future. I don’t think you have to be ready to lose 100% of what you invest (though it’s possible), but 50% or so is certainly a reasonable expectation.

  • MyMoneyDesign August 26, 2013

    If there’s anything I remember about my statistics classes back in college, its that you can present data and graphs to tell any story you want to. When people talk about returns such as this they have become almost meaningless to me because in the long run I know from folks like John Bogle that everything will just revert back to ~8% market average over time. I think its very important for younger investors not to get too caught up in these figures and fool themselves into thinking that getting rich is going to be an easy thing.

    • Matt @ momanddadmoney August 27, 2013

      Wise words. It can be pretty exciting to talk about great recent returns, but just like the negative periods it will eventually smooth out to the mean. As one of my favorite saying goes: “This too shall pass”.

  • Shannon Ryan August 26, 2013

    Like Mrs. PoP said, “context is key”. It’s easy to spin numbers to make you look better and unfortunately too many people don’t take the time to do their due diligence. They see good numbers and growth and say sign me up! People are fascinating creatures. Most people invest for a long-term goal but they way they chose their investments or make decisions about them is from a short-term (sometimes daily) perspective on how they are performing.

    • Matt @ momanddadmoney August 27, 2013

      Great point on the asymmetry between the time frame of the goal and the time frame used for decision making. There’s often such a focus on recent performance when making investment decisions, and that’s almost always a bad idea.

  • Jacob @ iHeartBudgets August 26, 2013

    Just converted to a 100% index Roth recently after reading “Millionaire Teacher”. Feel like I’ve been ripped off for 10 years with Edward Jones 🙁

    Actively managed = Gouging your long term growth with unnecessary fees!

    • Matt @ momanddadmoney August 27, 2013

      Yep, you were almost certainly getting ripped off. Glad you figured that out while you’re still young! Sometimes the best way to learn something is by getting screwed over and having to learn the hard way.

  • AvgJoeMoney August 26, 2013

    Ha! I see your “average Joe” quote there and know you’re just knocking my huge potential with my soon-to-be money making machine! 😉

    Everything I have to say here has already been said, so I’ll ask a question: Have you ever read the book Stock Market Wizards?

    • Matt @ momanddadmoney August 27, 2013

      Hey now, you know I’ve got nothing but respect for you Joe! I fully expect your money-making machine to send you and all of your blogging friends to a worry-free life in Tahiti.

      Haven’t read that book. I took a quick look at it on Amazon and I have to say that my initial reaction is to stay away (I’m sure you’re shocked). Any particular reason you would recommend it?

  • Charles@gettingarichlife August 27, 2013

    The investment return should also be indexed against the asset class you are investing in. If your portfolio is heavy in small cap US stocks your benchmark shouldn’t be in the US Total Stock Market but instead small cap funds.

    • Matt @ momanddadmoney August 27, 2013

      I agree. The purpose here wasn’t to provide a comparison for every investment strategy out there, and I hopefully made that clear in the post. I absolutely agree with you that you need to match your benchmark with your strategy. My hope here was just to help people get thinking about the concept of finding a relevant comparison.

  • Your Daily Finance August 27, 2013

    I only worry about what I have gained and not the markets. They will and always correct and 20% gain can easily be 30% loss. I take profits and as long as I do so I lock in my gains. The I made 40% and you don’t know anything about the company I just shake my head. We all need a little luck but its what happens when the market is down. Then tell me how you are doing.

    • Matt @ momanddadmoney August 27, 2013

      But if you’re only worrying about what you’re doing and not at all comparing to the markets, how do you know if your effort is worthwhile? In the end, it’s all about reaching personal goals, and therefore return is somewhat irrelevant, but wouldn’t you want to know if your time and effort was actually producing results that were better than a simple index fund?

  • MoneySmartGuides August 27, 2013

    Great post! I invest using a passive strategy that earns me somewhere in the neighborhood of the stock market, so I don’t worry too much about how I did compared to the market. I’m not trying to beat it. I know that some years I’ll do a little better and other years I’ll do a little worse. What is important is that I stay invested for the long-term, following my financial plan. That is the best way to ensure success.

  • Grayson @ Debt Roundup August 27, 2013

    Great post Matt. I am always leery of people saying that they are beating the market hands down. I usually turn and run from them.

  • Laurie @thefrugalfarmer August 27, 2013

    Thanks for more useful info for us, Matt. That Vanguard fund is looking like the way to go more and more for us.

    • Matt @ momanddadmoney August 27, 2013

      Vanguard as a whole is just a great company. They know exactly who they are and they put the customer first (technically they’re owned by their fund-holders). There are other good options, but I trust Vanguard more than any of them.

  • PFUtopia August 27, 2013

    Personally, I’m not concerned with beating the market. My investments are tied up index funds. Even if those index funds fall short of the actual index, I’m not too concerned. In general, they’ll be pretty close and, as long as I’ve got my money earning approximately what the overall market is doing (+/- whatever small amount), I’m ok with that. I’d rather spend my time trying to increase other earnings.

    • Matt @ momanddadmoney August 27, 2013

      Sounds like you and I have the same approach. I like your point about focusing on increasing other earnings. That’s a much more helpful tact than chasing higher returns.

  • John S @ Frugal Rules August 27, 2013

    Good post Matt and like others have said, so much of it is about the context. When I hear someone claiming they can do this or that and that they can beat the market, I start wondering where the snake oil is hiding. 😉 Slow and steady wins the race and my focus is on what the market is doing. You win some and you lose some, but my focus is on the market for the long haul.

    • Matt @ momanddadmoney August 27, 2013

      Context is so key. Numbers without context can make sub-par performance sound great. I’m right there with you on focusing on market returns.

  • Edward - Entry Level Dilemma August 28, 2013

    The best time to invest is certainly at the start of a recovery after a recession! I opened my IRA in 2008. I have some funds that have actually doubled in value in that time! Pretty good considering that I freely admit I have very little clue as to what I’m doing.

  • Done by Forty August 28, 2013

    Benchmarking is awesome. It’s one of the value adds that we perform for our internal clients, and they’re either happy to get the information or pissed off when they find out the deal they’ve been happy with is actually not optimal.

    I’m bookmarking this chart because I know one of my friends or relatives is going to eventually tell me about this mutual fund or stock I need to buy…it’s up 29% since 2009, after all.

    • Matt @ momanddadmoney August 28, 2013

      I have to say that I don’t actually know what you do for work. I’m sure you’ve mentioned it before, but I can’t remember. What kind of benchmarking are you doing?

      And that was my exact hope for how people would use this information. Thanks a lot!

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