I think that to be fair, you need to take inflation into account when you assume rates of return and amounts of investment. In terms of real dollars, saving $2000 at age 25 is very different from saving $2000 at age 50.These are certainly legitimate comments! Let's take a look at the impact of inflation and what return we might expect.
And 8% in real returns strikes me as pretty unrealistic.
First, I have to agree with the commenter that people should know and understand the impact of inflation on the value of money. Let's take a look. According to this site. The average inflation from 2000-2010 was about 2.8%.
Assuming this average inflation rate stays the same, this means that $2000 in today's dollars would be worth approximately $4000 in 25 years. Conversely, when you invest $2000 in 25 years, it would be like only investing $1000 right now.
That being said, we are really comparing the difference between investing $2000 starting at 25 vs. 35. That's only 10 years, so the difference is not as big - $2636 as opposed to $2000. Conversely, when the person starting at age 35 invests $2000, it has the same economic impact of the 25 year-old investing about $1520.
That's still different, but not that significantly different.
So what would be the impact if the 35-year-old invests $2636/year instead of $200/year? We know from the previous post, that (assuming a 10% rate of return) the person contributing $2000/year from ages 25-35 ends up with about $612K at age 65 and the person contributing $2000/year from ages 35-65 ends up with about $362K. Using this calculator, we calculate what our return would be for 30 years (from ages 35-65) investing $2636/year at 10% compounded daily - it comes out to about $478K
The $478K that we get from investing $2636/year is better than the $362K we got from investing $2K/year from 35-65, but still far less than the $612K that we got from investing $2K from 25 to 35 and then stopping.
We see a similar result at an 8% projected rate of return, but the greater contribution from age 35-65 has more of an impact because the investment return is lesser. The person investing $2000/year from 25-35 and then stopping ends up with $324K while the person investing $2000/year from 35-65 ends up with about $241K and the person investing $2636/year ends up with about $317K
The main lesson to really take away is that the longer you give the investments to compound, the better - and that just a few years can have a big impact. Inflation (and adjusting for it) always has an impact, but the power of compounding is just huge.
Next - As for the total return to project, I agree that it is difficult to project the return of the SP500 in the short term. For example, the SP500's total return in 2009 was about +26.5%, while the total return in 2008 (one of the worst years in history) was -37%. Of course, since 1976 the SP500 has averaged about 10.5%. Wikipedia's page has some nice data. Also, check out Vanguard's Statement here -they state that during the 20th century (1900-1999) stocks produced an annualized total return of 10.37%.
That being said, the last 10 years have been tough on the SP500 and it is essentially flat. Conversely, my personal return on the SP500 portion of my investments over the last 10 years has been pretty good. The volatility of the market has provided plenty of buying opportunities.
So what will the future hold? My general belief is that we are going to see a regression to the mean - and the mean is 10-ish%/year. Of course, running counter to that is the US's very poor financial position and potential for increasing taxes (which typically slows growth). However, the last time I checked, the companies in the SP500 earned about 36% of their revenue outside the US, so they may not be as badly hurt by the US's lack of economic discipline.
Further, although I think that we will see a regression to the mean, the regression time could be decades. However, for someone who is 25 today, they have 4 decades of investment ahead in their future. I can't tell you what the return will be year-to-year, but I think that the total average return over those 4 decades will most likely be around 10%.
However, if you want to be a little more conservative over those 4 decades, say 8%.
In large part, I think that people's attitudes toward the SP500 are swayed based on the most recent performance and are not necessarily reflective of the SP500's long-term performance. Contrast the attitude in 2000 that "anything less than 15%/year was inconceivable" with the attitude at the start of 2009 that "the SP500 was doomed - DOOMED!" There have been periods of time when the SP500 underperformed for a long while - like during the great depression. However, even considering the impact of the great depression, the average return for the 100 years of the 1900s was 10.37%.
The current economic crisis is bad, but it is not as bad as the great depression. Let's take a look at the investment return that you got during the great depression. The great depression is commonly considered to have started in 1929, but it really did not reach its bottom until about 1932. Let's use this calculator to see what your annualized investment return would have been from January 1, 1929 to December 21, 1958 (30 years.)
We find that the annualized return even considering the great depression was 8.34%. Conversely, the current economic crisis is really not as bad as as the great depression and I would expect the annualized return for the next 30 years to be higher. However, even if I am wrong, this seems to provide a reasonable basis for using 8% as a conservative figure for the SP500 average return over a 30-year period.
Further, I think that most people would agree that we are past the nadir of the current economic crisis. Consequently, let's take a look at what your return would be like averaged over 30 years starting January 1, 1933 - after the worst point in the great depression. That gives us an annualized return of 13.11% for those 30 years.
Consequently, I am going to submit that an 8% annualized rate of return for the SP500 over the next 30 years does not seem to be unreasonable.