The S&P 500 is widely considered to be the best benchmark of the broader stock market. This cap-weighted index of 500 stocks provides the fundamental basis for total market performance, including benchmark averages. In simpler terms: you can judge the performance of your own portfolio by looking at how it performs vs. the S&P 500. It begs the question: what is the average annual return of the S&P 500?
There are several answers to this question, depending on how you look at it. As a representative indicator of the market itself, the index is subject to change. And, depending on how you measure its average, it can affect the benchmark for success that most people measure their own portfolios against.
Here’s a closer look at the average annual return of the S&P 500 considering all important factors.
A Tale of Two Indices
The S&P 500 index has been around since 1926, representative of the broader stock market in aggregate. However, the composition of the index changed sharply in 1957 when it expanded from ~90 stocks to ~500. While this reconstitution was necessary to accommodate the growing number of public companies, it also affected the average of the index’s performance. As a result, it’s best to examine historical returns from three standpoints:
- 1926 to the present, regardless of composition, the S&P 500 index averages 10%.
- 1926 to 1956, the 90-stock composition averaged roughly 12% annual returns.
- 1957 to the present, the 500-stock composition averages about 8% annually.
If you’re looking for a historical benchmark to better-understand the pace of the market, it’s often best to use the 10% annual return, since it encompasses the entirety of the index, from inception to present. That said, many investors choose to use the 8% annual return since the index expanded to 500 companies, believing it a truer average. The choice is largely preference.
The Highs and Lows of the Market
Another big consideration in determining the average annual return of the S&P 500 is time horizon. Different segments of time will yield different results based on the current events of the economy. For example:
- The year-to-date average return of the S&P 500 is ~23%.
- Five-year average return of the S&P 500 is roughly ~15%.
- 10-year average return of the S&P 500 is about ~14%.
The reason for these differing average returns has to do with market highs and lows, and the presence of bullish and bearish trends. The more years factored into the average, the greater the ebb and flow. For example, the ~100-year average of the S&P 500 sits at 10%, but includes years like 1929, when the market lost half its value, and 1995, when it returned 37%. Over a shorter time horizon, these types of outliers greatly affect the average.
In determining a sufficiently relevant average annual return for the S&P 500, it’s best to either use the total historical return (10%) or the 10-year average return, for a more recent average.
Is the S&P 500 Annual Average Accurate?
The S&P 500 is one of several major indices used to show broad-market performance. Other major indicators are the Dow Jones Industrial Average and the Nasdaq Composite Index. The S&P 500 is far and away the most widely tracked and cited of the major indices, largely because it’s the biggest. Due to its composition (505 stocks) and cap-weighted nature, it serves as a reliable benchmark in representing a more diverse subsect of the industry.
This isn’t to say that the Dow Jones Industrial Average or Nasdaq Composite Index aren’t accurate! These indices simply tend to skew more representative of larger companies. The Dow Jones Industrial Index is a price-weighted index and the 2,500 companies featured in the Nasdaq Composite Index skew more tech-heavy, lacking representation from industrials and utilities.
Pacing the Market Average
As a representative of the broad stock market, many passive investors choose to index themselves using the S&P 500 as a benchmark. One of the most-tracked and -traded funds in the world is the SPDR® S&P 500 ETF (SPY). This ETF mimics the price and yield of the index, giving investors the same level of exposure and identical returns. This is known as pacing the market.
Pacing the market is a defensive investment strategy. In latching on to the market average, investors hedge against risk and volatility that come from more selective stock picking. Through this strategy, investors will never do worse than the market average—although, they’ll never do better than it, either. It’s a strategy commonly recommended for new investors and risk-averse individuals.
Pacing the market is a great way to beat inflation and grow your wealth at the market’s average rate of return.
Know the Average to Beat the Average
Most people concern themselves with the average annual return of the S&P 500 so they can benchmark their own portfolio’s performance and set expectations for gains. If the average return is 10% and the S&P 500 returns 12%, it beats the average. If your portfolio returned 18%, it beat both the current rate of return and the historical average.
For all intents and purposes, the S&P 500 is the stock market, which means it’s subject to ups and downs every day, week, month and year. The longer the time horizon, the smoother its trajectory and the simpler it is to calculate an average. If you’re trying to beat the average, consider how long you plan to stay invested, then look that many years back to see the average annual return for the S&P 500 over that time. Then, prepare to beat that average, or at the very least, pace it.