For those looking to invest for the first time, it’s essential to look at what happens if you put your money in a regular savings account. A lot of people do this for fear of losing all their money. However, most of the interest you earn is lost due to inflation.
Inflation sits on an average of 3% per year since 1900. It’s a silent killer that vaporizes your savings over the long term. To make it more concrete, anyone who saves 10.000 EUR sees his buying power diminish to 9200 EUR over 5 years. Fifty years later, only a tiny smoldering heap of cash remains; you accumulate a whopping minus 75 percent (see table). Of course, you don’t just keep it under your mattress, so thanks to the interest you get from your bank, but it’s insufficient to counter the inflation.
Stocks are the way to go
For the past 150 years, bonds could compensate for the inflation and even provide a small extra of about 2.3%. This type of investment supplied an average real return of 6% over the past 150 years (including reinvestment of dividends). If you want to see bigger returns and can invest long term, you must look at stocks.
6% might not seem like much, but when converted to ‘nominal’ yields, including inflation, this gives you 9% per year.
How much return on €10,000?
A student(16) earns 2,000/y for 5 years
|At the age of …||Investing in …|
(6% real return)
(2.3% real return)
(Inflation of 2%)
|21 (after 5 years)||€11274||€13,219||€9,200|
|30 (after 14 years)||€16,895||€16,946||€7,805|
|50 (after 34 years)||€54,184||€29,444||€4,168|
|67 (after 51 years)||€145,905||€47,085||€2,446|
Inflation: the 8th wonder of the world
Those who think 6% isn’t much might change their mind once they realize this return can repeat itself, year after year. Over the long term, this amasses to a massive amount. Albert Einstein didn’t call inflation the 8th wonder of the world for nothing.
Therefore, turning even a small starting amount into a fortune is possible. There is one condition: starting early and/or a high return. Combining both is, of course, the ideal.
If a student were to invest the money he earns from holiday jobs in shares instead of consuming it, he wouldn’t have to save much for the rest of his life (see the above table). With an average real return of 6%/year, he increases his purchasing power by 14.5%. His 10,000 euros has become 145,905 euros. If this smart student succeeds in achieving a 7.25% return, his purchasing power will increase to more than 300,000 euros. Small annual differences produce explosive differences through the miracle of compound interest. Hence the big difference with the final amount if he invests in bonds.
6% Real stock market return
Of course, the 6% is an average over a very long period (+120 years). Credit Suisse has an extensive research paper on Long-term returns, and here, we see a real global return of 5.3%. However, this includes data from as early as the 1900s, which is arguably unreliable.
More reliable data started when the US Central Certificate Service, introduced in 1968 to handle surging trading volumes, was replaced by the Depository Trust Company in 1973. Rather than physical stock certificates, investors were now more likely to have their stocks held electronically at a central depository.
If we take the period from 1971 to 2020, we get exactly 6%.
This is an average, of course. Many investors have not forgotten 2008, one of the worst stock market years ever. Even the major stock exchanges suddenly dropped more than 40%. Or the ongoing Covid pandemic with a substantial decline of over 20% in March 2020.
But then there are also years in which share prices have risen by dozens of percent, with the current year being a perfect example. An episode of high returns often follows a weak period.
It’s hard to find all-world 20-year returns, but at least the S&P 500 never had a 20-year negative return.
So even if you enter the stock market at a terrible time, you can end up with a profit – provided you are patient. Those who bought shares in the year 2000, at the peak of the Internet bubble, and then went down with the financial crisis in 2008, saw their capital halved twice. But today, even the unlucky person has a profit. Overall, the major stock exchanges from 23 countries have since offered a return of some 80% (in nominal terms). Admittedly, that does not give a 6% real return per year for those 16 years. But even those unlucky people have seen their purchasing power increase by more than 2 percent a year. That is not what savings account yields.
- Dimson, E., Marsh, P., & Staunton, M. (2021). Credit Suisse Global Investment Returns Yearbook 2021 (2021 ed.). Credit Suisse Research Institute.