In spite of COVID the stock market had a relatively good year in 2020. The S&P 500 (or the “market”) which just measures the stock performance of 500 large companies listed on US stock exchanges finished 16.3% higher in 2020.
Based on my calculations, since 1928 the S&P 500 has returned about 7.8% a year on average, which is close to the roughly 8% annual return over the long term that other websites have calculated. So the 16.3% return the stock market had in 2020 was more than double the historical average. To help visualize how the stock market’s annual returns look, below is a distribution of the yearly returns for the S&P 500 since 1928 for reference:
More often than not, the market finishes the year up, but there’s been years where the market has been down over a third of its value. Needless to say, its extremely hard to know, if not impossible to consistently predict, where the market will be weeks, months or years from now. For that reason, conventional wisdom says that the best strategy for the average person who puts their money into the stock market is just to simply buy a broad-based index (like the S&P 500 or the Dow Jones Industrial Average) and to not waste your time picking a particular stock or attempting to time the market.1
As you can see from the first chart above, the U.S. stock market can fluctuate considerably year-over-year, but over the long term the market has always gone up:
This relentless upward trend is part of the reason the stock market is one of the greatest wealth-building tools in the world and why people say compounding returns (or compound interest) is one of the most economically powerful forces to ever exist.
Quick case and point, if you had $10,000 when you turned 18 and just had that money sit in the S&P 500, in 50 years when you retire at the age of 67, that $10,000 would have grown into about $427,502 assuming a 7.8% annual rate of return:
The more time you add, the greater the power and growth becomes. For example, if the day your child was born you put $6,525 into the S&P 500, by the time they retire at age 67, they would be a millionaire:
Generational wealth is a beautiful thing if your family has it. And extremely advantageous if you have it. 🤔
The stock market is good at generating wealth, but for the average person, until you take care of some of the basic things like eliminating high interest credit card debt and improve your finances by reducing unnecessary spending and increasing your savings rate, you really shouldn’t focus on putting money into the stock market in my opinion.
I’m not saying you should totally ignore the stock market until you get all your financial ducks in a row because I think it’s very important for the average person to at least try to learn how the stock market works at a basic level and understand why it’s so great at building wealth over the long term. For that reason, I strongly advise and encourage anyone interested in being financially independent, regardless of where you are on your path to improving your finances, to open a brokerage account (like Robinhood, Etrade, etc) and put no more than $100 into the account to buy stock in a large company, broad-based index or exchange traded fund (ETF) to just learn how it works, understand the potential risks and rewards, and to experience how money is gained or lost.
You’re not going to double your $100 overnight or lose all your money in a single day, though you definitely can if you buy extremely risky investments like penny stocks or options, but no rational person should be doing those types of highly risky things with any money they are not willing to completely lose.
For the average person who may be very unfamiliar with buying stocks, the point is to learn what to realistically expect, over the short and long term, from putting your money into the stock market so that when or if you’re ever at the point you can start heavily contributing money into your IRA, 401k or brokerage account, you are more informed and better prepared to manage your own investments and plow your money into the S&P 500 index if you choose to go that route.
