Proof! Average Rate Of Return Of The Stock Market? Win Every Argument! - YouTube

I'm Sebastian St James. This video seeks to answer  one clearly defined question! And that is how much  

does the stock market return? It is the  definitive answer! Once you have this answer,  

your life will be definitively better. I  shall explain why. When I read some forums,  

when I read some financial articles, there's a  number of ranges which I get for how much they  

say the stock market will return. Seven or eight  percent, I read. Often up to twelve percent.  

Twelve! Seven! That's a massive difference, there.  You could drive a car through it! So what is the  

answer. How much does the stock market actually  grow by? We need to know! And once you know,  

this video will allow you to win arguments against  your friends, because you'll know the truth,  

and they won't! And we all love beating  our friends. If you don't have any friends,  

then just go to Facebook finance groups and beat  them over the head with your newfound knowledge.  

If you're planning to invest in stocks at  all, you will need to know this figure,  

so you can plan. For example, if it's five  percent return, then I need a lot more  

money before I can retire! If it's 50% return,  well, I can retire yesterday. The question is,  

what is that percentage? Firstly, when I say the  stock market, which stock market am I actually  

talking about? There is so many! Well there is the  American stock market. Well there's a couple in  

America, if not more! There's the ASX 200. There's  the FTSE! It goes on and on. But there's only one  

that we're going to deal with today, because it is  the most important. Yeah. Just ask any American.  

If we look at the graph - whoa - one stands out  as much bigger than all the rest, or fatter,  

but we don't use that term around Americans.  So the market that we'll be focusing on,  

because it's so dominant, is the S&P 500, which  represents the top 500 stocks of the U.S. market.  

Is it possible, that the data I give you,  here, will be out of date by next week?  

Is the S&P 500 going to no longer be the  dominant market, in say, 10 years time? Well,  

anything's possible. Here is a chart that predicts  the future! I know, it's very special. 2030, it  

says that the U.S. market will be 35%, and china  will be 19 percent. So, the details I give you  

here should still be valid. Question number one.  When I talk about the return of the stock market,  

am I including dividends! It matters, right?  It's a few percentage more if I include them, or  

less if I don't. So let's get our terms straight.  When I'm talking about stock market return, here,  

I am including dividends. That's right, the whole  total return. So we've got our market, the S&P  

500, but over what period of time? I mean, if it's  the last 12 months, or the last five years, those  

figures are going to be so much different than if  we look back, say, five years previous to that.  

We'll be talking the entire time period of the  S&P. I kid you not. Right back to the beginning.  

That's the average we will be taking. Okay. So  that's the average. In the short term, of course,  

the market may outperform the average,  or underperform the average, of course.  

But the figure that we're after, is the historical  average, and it doesn't necessarily predict what  

the stock market will do next year or the year  after. But that's not the point of this video.  

So S&P 500. We've probably all heard of it.  What does it stand for? Standard & Poor's.  

500 is the approximate number of stocks which are  in the index. Do you know it's actually higher?  

How can it be higher than 500? Should they not  update the number? Well some of those stocks  

,like Google, tends to be listed more than once.  And they do have more than 500 stocks in total.  

The S&P 500 is market-cap-weighted. Oh,  big term! What does that mean? Well,  

the larger the company is, the larger percentage  of the stock market index it takes up. It makes  

sense. If apple is huge, then it needs to take up  a huge percentage of the index. How far can I go  

back? What sort of time frame are we talking about  for this long term average? Well the S&P 500 goes  

back to 1957. Before I was born. I know. It's a  long time ago. In which case, the S&P took on 500  

stocks. And that is the magical date for  one of our figures. What do you mean one?  

You said there was only going to be one! Yes  there is. But there is a second, sneaky one.  

The S&P actually dates back to the 1920s, where  they had 90 stocks. So we can actually go back,  

and use that sort of data, because we have it  available to us. The average annualized return,  

since its inception in 1926 - this is the S&P,  the original one - through to December 31 in 2021,  

is 10.49%. That is not bad. Alright. That's figure  number one. Here is a source of the raw data.  

Importantly, you can see that we have included  dividends. And it has an average of 12.39% 12.39?  

Didn't you tell me it was like 10 odd? Fear not.  We shall explain what the discrepancy, here is.  

The annualized CAGR is 10.49 percent. Okay. So  that's the figure you quoted to me earlier. The  

average annualized return, since adopting the  500 stocks - so the S&P 500 pure - back in 1957,  

is 10.67%. So it's actually slightly higher  than our previous figure! Once again,  

we have two averages. One at 12.05, and the  other at 10.67! So we keep getting two averages,  

and this is slightly embarrassing. I told you  there would be one figure. We need to sort out  

what does average mean. We intuitively know,  but do you know, the average that you know, is  

probably wrong. So what does average mean? I will  tell you, right after you subscribe to my channel.  

Okay. So what are our two averages? One is  the arithmetic mean, or the simple average,  

as we might want to call that. That  is where I get 10 people in a room.  

I measure their weight. Everybody likes to give  me those measurements. And I average them out by  

adding them up and then dividing it by the number  of people in the room. That is the simple average.  

The simple average that we use to get the average  of people's weight, is on average, not very good  

when it comes to working out the average rate  of return for money. And I will tell you why.  

It's all to do with that compounding interest that  you may have heard about. CAGR stands for Compound  

Annual Growth Rate. Write that down! This is all  very interesting, Sebastian, but can you summarize  

what these differences are? I can, in a table. We  have arithmetic mean, on the left, which is great  

for finding out averages of everyday numbers. And  on the right, we have the geometric mean, which is  

best for looking at sequences of return over time.  Do I understand these formulas? Do I understand,  

personally, the difference? Yes. I've turned this  into a spreadsheet, so I've done all the work  

for you. Here is a table of numbers. I know. It's  impressive. It starts off with a thousand dollars,  

which is the money, hypothetically, I'm giving  to you! Certain things happen, the money grows  

over time by 10 percent a year, and right down  the bottom at position 10, we have $2 357.95  

So after consistent 10% a year, that's the  money we're left over. Fascinating! So you've  

doubled my money. Can you tell me the average  rate of return on that? Yes I can! It's 10%  

Every year was 10%! It is pretty  obvious what the average is. But  

let's do the math! Let's plug in the formulas  that we've learned, and see if it agrees with  

the reality of how I constructed this table in the  first place. The simple average, gives us 10%. So  

how do we work those figures out? What we do,  is we add up all the rates of return, which is,  

you know, 10 percent. So 90%, divided by 9, is  10%. Oh! We got the right answer! Fancy that.  

The CAGR is a much more complicated formula, but  I will break it down for you. It is the end value,  

which is 2 357.95 cents, divided by the start  value, which is one thousand dollars. That's what  

I gave you originally. To the power of one minus  the years, so one minus nine is eight, minus one.  

What does that mean? Well let's plug that in  and find out. The CAGR, is ten percent! Fancy  

that. We came up with the same answer. Thus  proving that the simple average and the CAGR,  

actually agree with the original  percentage that I manually put in.  

Hooray! it's worked! But wait. If those numbers  are not quite so simple, if they weren't all 10%,  

year after year after year, Something tricksy  may happen! Something false may come this way.  

Let's go to the next table. I started with a  thousand dollars again, and minus one percent  

for the first year. Okay. That was a bit of a down  market. Minus six. Oh it's getting worse. Five.  

Five. Oh thank goodness we're coming back up.  Right down to fourteen percent. So these are  

reasonable figures. That's exactly what the stock  market could do! If we plug those random rates of  

return into the original thousand dollars, we  go down to one thousand, one hundred ninety one  

dollars, and thirty two cents. Yeah, I haven't  doubled it, like I did in the previous example!  

What's gone wrong? This is kind of a bit sucky!  Okay. So I see, there, on the right hand side,  

you have the actual rate of returns each year. I  want to know what the average rate is, across all  

that time period. Well fortunately, I have the  formulas to help you with that. If we average  

out those percentages, in a simple average, it  gives us 2.56 percent. Dismal! But go on. The CAGR  

is 1.96 percent. Ah! I notice a difference. If  those rates of return are too simple for you,  

let me up the difficulty level. I'm gonna take the  same answer, and add more decimal places. Getting  

a bit wild. So the two point five six percent,  becomes two point five five five five five six,  

which is actually the percentage it is. And  the one point nine six, becomes one 1.96414,  

which you knew that already, didn't you? So which  is correct? Is the simple average the right one,  

or is the CAGR the right one? Well the only  way to find out, is to plug that back in,  

and see which percentage, if any actually  gives us the right answer. On the left,  

is the CAGR figures of 1.96414. Now, it's  the same, year after year after year,  

because this is the average figure! That's how  it works. On the right is 2.5556! That's easy  

for you to say. And that is a prediction of  the simple average. And what do we get? Well,  

on the left with the CAGR, I get an amount of $1191.32 cents. What was I expecting?  

I was expecting $1 191.32 cents. Oh! Exact to the percent! On the  

right hand side, we get a total of $1 254.97!  Whoa! Well that's not the same as $1191.32.  

Something has gone wrong, there! Yes. What's gone  wrong? The simple is too simple. What we have  

discovered, is that the simple average is a lie!  Simple proof that the simple average, is simply  

not up to par. And the CAGR is the average which  we need! Now that we know the CAGR - which is your  

new favorite word for the day - is the correct  figure we should be taking, let's summarize it  

up. Over the last 96 years, the S&P has returned  10.49%. And in the last 65 years, in case you want  

to just narrow down on the S&P 500 - maybe the  500 matters to you - then return is 10.67 percent.  

The S&P 500 is an actually slightly higher return  than the full S&P. Interesting. So if I wanted to  

have one figure. I don't want two! You promised  me one, Sebastian! Then do a bit of rounding,  

and we'll say the market, on average, returns  10.5% That is alright for long-term historical  

average. But I am expecting things to go wrong in  the future. The financial market is in turmoil.  

Interest rates are going up and up. Inflation is  going up and up! And the Fed. has pumped so much  

financial easing into the market! Our money is  absolutely worthless. This will not give me the  

same rate of returns now, as it did 50 years  ago. It's absolutely impossible! To this end,  

some people are quoting, seven, eight percent  should be the rate that we are trusting going  

forward. They're made up figures! They come  from nowhere! They come from a fear response.  

Historical averages, which include everything  right up to this year - everything - is it  

the only figure that we can go on. Because that's  fact, and everything else is just predictions. So,  

next time you're in a heated argument about  the rate of return in the share market,  

and you pop in that it's going to be 10.5 percent,  and nobody agrees with you. What would you know!  

Who are you anyway? You can point them back to  this video, as definitive proof. So the question  

has been answered. Peace has been restored across  the world. Now you have that information, what you  

should do is to research into stocks further.  Do you know, there is risk and there's reward,  

in the stock market. And balancing those two  out is very important. I've done a video,  

specifically, on risk versus reward you can  watch that here, now. Go ahead and click on it.