The above graph plots the history of a $1 investment in 1871. The bottom curve (blue) shows the price history of index, while the top curve (red) shows the price history of an investment with dividends reinvested. The index itself tracks inflation closely (the index has an average return rate of 3.91%/year  not much higher than the 3.26%/year that the CPI data gives). The investment with dividends reinvested has an average annual return rate of 8.61%/year. To calculate these rates, I took the ratio of the value of the investment at one year to the value from the previous year. I then took a geometric mean of these values to come up with the average return rate.
The below graph is somewhat more interesting because it has been CPIadjusted. All values are given in 2009 dollars.
Once again, the top curve (red) shows the investment history with dividends reinvested, while the bottom curve (blue) is an inflationadjusted price history of the index. In this case the index has an average return rate of 1.80%/year, while the dividendsreinvested investment has a return rate of 6.41%/year. The following histogram shows the spread in returns for the inflationadjusted, dividendsreinvested case:
If history repeats itself, a longterm investor can expect to earn an inflationadjusted 6.41%/year in the S&P 500. After a 15% capitalgains tax, the investor will be left with a 5.45%/year investment (some fraction of which will be lost to a financial adviser/firm). At 5.45%/year, the investment should double in just under 13 years (the doubling time is given by 100%*ln(2)/investment rate). This 5.45%/year is significantly less than the 10%/year I seem to remember mutual fund advisers quoting. This leads me to believe that the real way to get rich (other than, you know, earning money) is to maximize your personal savings rate (the American average being 6.98%/year).
Copyright © 2010 Peter Dolph




