[The data on global stock returns in this post were updated in January of 2022, where new data were available.]

Spurred by the popularity of the historical returns data presented here at Mindfully Investing, I’m continuing to evaluate additional historical return datasets.  For today’s post, I wanted to take a closer look at the history of global stock returns.

Making Sense of Global Stocks

Why consider stocks beyond the U.S.?  For those who don’t live in the U.S., this probably seems like a myopic question.  But consider that the U.S. makes up more than half (55%) of the world stock market capitalization as shown in this pie graph from Credit Suisse.

Foreign investors understandably seek out this big U.S. chunk of the world stock market resulting in foreign investment representing 40% of U.S. stocks.

But investing solely in U.S. stocks ignores the other half of the world’s stock markets.  And that means you’re ignoring an easy way to substantially diversify your stock portfolio.  While that’s not a recommendation to invest in world stocks, it’s a good reason to at least evaluate how non-U.S. stocks might fit into your long-term investment portfolio.

Mindful investors favor investing via mutual funds and exchange-traded funds (ETFs), rather than trying to pick individual stocks for reasons laid out here.  When you look at the world of stock funds you will often see funds described as being “ex-U.S.”  The most common example is “Developed-Markets Ex-U.S.”.  This simply means that the fund invests in developed markets all over the world except the U.S.

The way fund providers define a “developed market” can vary, but generally, they look at criteria such as a country’s: income per capita, per capita gross domestic product, level of industrialization, the standard of living, and level of technological infrastructure.  Countries that are less developed by these metrics are called “emerging markets”, and markets that are even less developed are called “frontier markets”.  Here’s a list from MSCI, a company that classifies the world’s stock markets.

This pie graph from investment firm BBH shows the relative sizes of the stock markets in the U.S., other developed markets, and emerging markets.  It also illustrates that China and India are the two largest emerging markets by far.

The 39% global market cap for the U.S. in this pie graph from BBH may seem to contradict the 55% in the first pie graph from Credit Suisse.  However, the first pie graph focuses mostly on developed markets (with the addition of China), while the pie second graph includes many additional emerging market countries.  Also, the second pie graph shows that, since 2003, the U.S. market capitalization has been shrinking relative to the rest of the world, which suggests even more reason to consider non-U.S. stocks.

Historical Returns by Country

Probably the best summary of global stock returns comes from an annual Credit Suisse report prepared by researchers Elroy Dimson, Paul Marsh, and Mike Staunton.  They tracked down historical data going back to 1900 for 23 countries including the U.S.  This graph shows the nominal (not inflation-adjusted) annualized returns (Compound Annual Growth Rate; CAGR) by country from 1900 to 2020 and compares it to the U.S., Europe, Emerging Markets, Developed Markets, and a World aggregate of all markets.

(All returns in the graph are in U.S. dollar terms, and I converted the study’s inflation-adjusted returns to nominal returns using a historical average of 3% annual inflation over this entire period.  Some values are estimated from charts in the report because Credit Suisse doesn’t publically release the raw data from the Dimson, Marsh, and Staunton study. )

The fact that U.S. stock returns beat every other country except Australia over 120 years is one reason that some expert investors like Warren Buffett and Jack Bogle avoid foreign stocks.  It’s enticing and easy to attribute America’s superb historical stock performance to the popular idea of American exceptionalism, which both Buffett and Bogle have sometimes mentioned.  “Nothing can stop America when you get right down to it. Never bet against America.”, Buffett has said.

But by this logic, doesn’t Australia’s superior performance indicate that it’s even more exceptional than the U.S.?  Wouldn’t a portfolio composed of 100% Australian stocks be even better?  I think not.  Further, a patriotic view of the U.S. stock market ignores huge events in the last 120 years that have shaped each countries long-term stock performance.  What if world wars had ground the U.S. economy to dust twice in 30 years as happened to Germany?  In that event, it’s unlikely that the U.S. would be near the top of this historical returns list or that the case for future American exceptionalism would seem so strong.

More detailed data are available for a shorter period going back to 1970 from the MSCI Developed Market country indices.  You may be interested in determining annualized returns between specific years for individual countries.  Similar to my historical return calculators for stocks, bonds, cash, alternative real estate, and corporate bonds, this calculator provides annualized stock returns (both nominal and inflation-adjusted) between any two dates based on 22 Developed Market countries using MSCI data.  Again, all returns are calculated on a U.S. dollar basis.  (Note that the data for some countries do not extend all the way back to 1970.  If you enter a date for a country without data for that year, you will get an error message of “-100%”)

Historical Returns of Developed Markets

While stock funds that specialize in individual countries are readily available and popular, a mindful view of global diversification suggests that it’s better to spread your bets across multiple countries.  One of the most common examples is “developed market” funds, which typically include all the countries from this category in the MSCI classification system.  What’s the historical performance of these baskets of developed market stocks?

The “developed market” value (gray bar) from the above bar graph provides a good estimate of nominal annualized returns for these stock markets since 1900.  Thus, we can say that the long-term return is:

• Developed Market stocks including the U.S. since 1900 – 8.4%.

However, if you’re like me, you already have some U.S. stock investments.  So, a developed market fund that excludes the U.S. is a more interesting comparison.  The MSCI Developed Market Index provides data going back to 1970, and it excludes the U.S.  The reported annualized nominal return over this much shorter timeframe was:

• Developed Market stocks excluding the U.S. since 1970 – 9.4%.

Given that two time periods are presented here, we can’t directly compare the including U.S.-statistic to the excluding-U.S. statistic.

Also, the 9.4% return for developed markets excluding the U.S. is a long-term average, which means that over shorter periods those stock returns diverged substantially from this central tendency.  This table shows some additional descriptive statistics for the nominal annual returns from developed-market stocks (excluding the U.S.) from 1970 through 2021.

Here’s another calculator that provides annualized Developed Market (excluding the U.S.) stock returns (both nominal and inflation-adjusted) between any two dates based on the MSCI Index data back to 1970 as well as Portfolio Visualizer data back to 1986.  I’ve provided both datasets for comparative purposes because they often provide slightly different annualized returns for the same period.  Again, take note that if you enter dates prior to 1986 for the Portfolio Visualizer option, you’ll get an error message that reads “-100%”.

Historical Returns of Emerging Markets

How about emerging market stocks?  The Credit Suisse study going back to 1900 only includes a couple of emerging market stocks.  Again, the MSCI Emerging Markets Index had the longest data set I could find for emerging market stocks, but it only goes back to 1988.  So, unlike the 120-year history of developed markets, we only have a meager 34-year history for emerging market stocks.  In this short timeframe the average annualized nominal return was:

• Emerging Market stocks since 1988 – 10.5%

Here are some additional descriptive statistics for emerging market stock returns from 1988 through 2021.

And here’s a calculator that will give you annualized nominal and inflation-adjusted returns for emerging-market stocks between any two years going back using both the MSCI Emerging Markets Index going back to 1988 and the Portfolio Visualizer data going back to 1995.  Again, take note that if you enter dates prior to 1995 for the Portfolio Visualizer option, you’ll get an error message that reads “-100%”.

Historical Risks for Global Stocks

Because higher returns are usually associated with higher risks of losing money, it’s prudent to evaluate the long-term balance of both returns and risks for every investment, including global stocks.  Volatility, as measured by the standard deviation of the routine ups and downs of returns over time, is the most common (but somewhat flawed) measure of investment risk.

Unfortunately, the Credit Suisse report going back to 1900 doesn’t provide much detailed volatility data by country or market classification.  However, they mention that for developed markets (including the U.S. plus China) the volatility (standard deviation) of inflation-adjusted returns since 1900 has been about 17.4%.

In my last post on corporate bonds, I gathered volatility and return data for a wide range of asset classes covering the last 20 years or so.  While it would be nice to use some of the longer stretches of volatility data available for some assets, using a consistent timeframe across all assets ensures that we aren’t including unusual economic events for some assets and ignoring them for others.

Looking across multiple reputable data sources, the most consistent period covering the widest range of asset classes I could find was from 2003 to 2019.  Seventeen years is not great, but it’s worth a look.  Here’s the graph plotting risk versus returns since 2003 for multiple asset classes.

The squares represent the actual nominal returns (CAGR) and risks (standard deviation) in this period, and the round dots represent the “theoretical”² or expected relationship between risk and returns for these asset classes.  The two dotted lines represent the best fit relationships for both the theoretical and actual data.

We’ve seen that U.S. stocks have often had higher returns than non-U.S. stocks.  Therefore, the theoretical assumptions about risk-return relationships would predict that U.S. stocks are more volatile than non-U.S. stocks.   Instead, in the last two decades or so developed-market (ex.-U.S.) and emerging market stocks have been more volatile than U.S. stocks while producing lower returns!

Conclusions

Both the last century and the last two decades of investing suggest that global stocks may offer a poor balance of risks and returns as compared to U.S. stocks.  The problem is that I can select another evaluation period and come up with an entirely different conclusion.  For example, here’s the risk-return information for the 10 years from 2000 to 2009:

This was one of the most devastating periods in U.S. stock market history, with massive crashes in 2000 and again in 2008/2009.  It was called the “lost decade” for U.S. investors.  And yet the risk-return relationship is exactly what you might expect; U.S. stocks had lower returns and lower volatility than global stocks.

Perhaps more importantly, the lost decade illustrates one of the clear advantages of diversification.  Emerging market stock returns absolutely crushed the lost decade.  While we might endure lower returns and higher risks for many years, there is the potential (and only the “potential” on any given day) that holding a geographic variety of stocks can help mitigate the impact of market turmoils as compared to less diversified portfolios.

I’ve argued that global stock diversification is a mindful way to invest, and I’ve presented some example portfolios that fit the bill.  But I’ve also said that stock diversification is no guarantee of better performance as compared to a less diversified approach like a U.S.-only portfolio.

While it may seem like I’m trying to sell the idea of a globally diversified stock portfolio, I wouldn’t go so far as to “recommend” it.  That’s because we can never predict the next decade of stock performance, or the future in general.  Just as we have to learn to live with many of life’s uncertainties, investors have to live with the uncertainty inherent to stock investing.  Consistent with the four cornerstones of mindful investing, you’ll have to wrestle with this uncertainty yourself and rationally decide the extent to which you want to globally diversify your stock holdings.

1 – The arithmetic average of annual returns differs from annualized returns (CAGR) as discussed more here.

2 – By “theoretical”, I mean that a quick review of any basic investing references shows that professionals assume a certain hierarchy of risks and returns among these asset classes based on historical data and experience.  Nonetheless, it’s widely understood that the actual hierarchy of risks or returns in any given period can vary substantially from this theoretical assumption.  

Every year around this time I update my summary of expected return forecasts for stocks and bonds made by various financial companies.  I started doing this in 2018 for my own benefit, but I recently got a message from the blogger Froogle Stoodent saying that my forecast summary was a “public service”.  So, it’s nice to see that at least a few people share my interest in this topic.

I also use this information to update my regular Mindfully Investing article on expected future returns and risks.  But I probably won’t get to that for another week or so.

I’ve found over the years that predicting the future, at least in the world of investing, is a fool’s errand.  But paradoxically, mindful investors also know that building a forward-looking investing plan is one of the best ways to avoid costly investing surprises.  Specifically, an investing plan should include estimates of the returns you can reasonably expect from your specific investment portfolio.  Such forecasts help determine whether you’re investing goals, like retiring by a certain age, are realistic or not.

Unfortunately, individual investors often make overly optimistic assumptions about expected returns.  For example, the U.S. has one of the best long-term track records for stock returns in the world, with a historical average annualized return of about 9%.  But a recent survey by Natixis found that individual investors with more than $100,000 in investable assets were assuming future annual returns that are nearly twice that high (17.3%!) as shown in this graph.

And individual investors’ expectations have nearly doubled since 2017.  That’s most likely because an investment in the S&P 500 has produced a whopping 15.9% annualized return over the last four years.  It seems that investors expect the good times to keep rolling on forever.  But Buddhists like to point out that nothing lasts forever; every trend changes eventually.

The above graph also suggests that financial advisers’ expectations are more realistic at around a 6.7% annual return.  But as you’re about to see, that’s still pretty optimistic in light of the return forecasts available from the large financial firms.

2021 Forecasts

First, I should note that I found a lot more return forecasts this year because I discovered that the finance code word for expected return is “Capital Market Assumption.”  This is a good reminder to all readers that I’m a retired scientist just trying to figure all this stuff out myself.  I’m sure any Certified Financial Planner would have been aware of this jargon, but I was not (until now).  Regardless, I’ve noticed that these firms tend to run in a pack and, and except for a few outliers, adding more estimates did not drastically expand the overall range of this year’s forecasts.

This year, I also found a survey of investment firms by Horizon Actuarial Services that was incredibly useful.  The Horizon survey provides an overall average of the return forecasts from 39 firms, which includes some, but not all of the individual forecasts I found independently.

This plot shows long-term annual return expectations for various asset classes from 17 individual firms plus the Horizon average across 39 firms.  (Click on the image to enlarge it.)

All returns are on a nominal basis, meaning they are not adjusted for inflation.   I highlighted the Horizon survey overall average with a pink line connecting their forecast dots.  And as you would expect, those average forecasts fall in the middle of the pack for all the asset classes.  I also highlighted the forecasts from GMO with a red line because GMO is perennially the most pessimistic forecaster, and this year is no different.  In contrast, no firm was consistently the most optimistic across all asset classes.

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Just over 10 years ago, as I was mentally recovering from the Great Financial Crisis, I plotted my final drive to early retirement.  Before this time, I was not a particularly mindful investor.  Although I stayed relatively calm during the Great Financial Crisis, I made a few boneheads moves like moving mostly to cash in my 401K account for several months.

This experience motivated me to be less emotionally susceptible to future market gyrations.  And around this same time, I started to get into meditation and mindfulness, which resulted in the mindful investing approach described here at Mindfully Investing.

Using mindful investing principles, I started to realize that picking individual stocks was mainly a loser’s game.  I slowly converted my portfolio from a mixture of funds and individual stocks to a strict low-cost index investing approach.  But there are many flavors of index investing, so I had to choose a particular portfolio.  I considered several different options, which I’ll detail in a moment.

Now, after more than a decade of investing in low-cost stock index funds, I’ve started to wonder how my outcomes might have differed had I picked a different portfolio back in 2010.  In today’s post, I’m going to compare the performance of my candidate portfolios from 2010 to the one I actually picked and continue to use.

Mindfully Unmindful

I have to say that this is not a particularly mindful thought process.  Mindfulness practitioners see the obvious truth that only the present really exists, while the future and the past are just figments of our active imaginations.  In every sense, it doesn’t matter how other portfolios performed, because I can’t jump in a time machine and do it all over again.  There are no “do-overs” in investing.

Further, the math of such comparisons usually fosters nothing but regrets.  For example, if you randomly generate a handful of different portfolios and then back-test them, only one of them will have performed the best.  Or maybe two portfolios will have tied for the best.  So, the odds are that you’ll feel stupid for picking one of the “sub-optimal” portfolios.

However, this logic reminds me of that old advice that to control our emotional reactions, we shouldn’t “peek” at our portfolio balances too often.  In my view, mindfulness is obviously better than the “don’t peek” approach, because the mindful investor is better informed about reality but resists panicky decisions.  So, rather than being afraid of how my portfolio performed relative to other possible options, I choose to embrace this information and carry on with my investment game plan regardless of the results.

Aside from all that, I think there may be some value in comparing my predictive thought process from a decade ago to the reality that ensued.  Perhaps, it might reveal some cognitive biases in my decision that I can try to avoid in the future.  Or maybe I might find that I made some seemingly good choices, but for irrational reasons, which also might spur better future decisions.

Caveats

Before detailing the portfolios I considered in 2010, I should list what’s not included in this evaluation.  First, I’m ignoring the real estate portion of my portfolio because, over the last decade, I’ve jumped in and out of several rentals for practical reasons, and it’s simply too complicated to figure all that into my calculations.

Second, as I approached retirement I built up a cash reserve that represented 20% of my non-real estate investments for reasons that I describe in this article.  That cash came from new savings as they became available, and it really didn’t impact the remainder of my portfolio (in stock funds) one way or the other.

So, in today’s portfolio comparisons, I’m looking at how my investments performed outside of real estate and cash.  However, one of the candidate portfolios I’m about to describe contained bonds.  If I had selected that portfolio in 2010, I likely would have held less cash, because both bonds and cash serve a similar counterbalance function to stocks.  In this one case, my comparisons below are slightly apples-to-oranges, at least in terms of how I personally would have invested.

Portfolios of The Past

As best I can recall, in 2010 I considered about five different flavors of portfolios outside of my evolving real estate and cash holdings.  They were:

• Portfolio 1 – A World Stock market portfolio comprised of 60% in a U.S. stock fund, 25% in a developed market (excluding the U.S.) stock fund, and 15% in an emerging market stock fund.  This is the portfolio I chose in 2010, which I continue to hold today.
• Portfolio 2 – An approximation of the Warren Buffett portfolio, which as I defined it, contained 100% U.S. large-cap stocks as represented by an S&P 500 index fund.
• Portfolio 3 – An U.S. All Stock portfolio, which is 100% in one index fund that tracks the entire U.S. stock market.  Essentially, Portfolio 3 adds a little exposure to smaller U.S. stocks as compared to Portfolio 2.
• Portfolio 4 – A combined U.S. stock/U.S. Treasury Bond portfolio consisting of 70% of a U.S. all-stock fund and 30% of a 10-Year or intermediate Treasury Bond fund.
• Portfolio 5 – A U.S. Stock portfolio with a stronger tilt toward smaller stocks consisting of 60% in a large-cap fund, 20% in a mid-cap fund, and 20% in a small-cap fund.

I didn’t consider tilting toward “value” stocks because frankly, at the time I didn’t fully understand the value factor and how it’s supposed to work.

I plugged these five portfolios into Portfolio Visualizer’s asset allocation back-test calculator for the period from 2010 through the end of 2020.  I specified a $10,000 initial investment, additional contributions of $10,000 per year¹, and quarterly rebalancing.

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The blogger Physician on Fire recently, and kindly, syndicated one of my posts about the historical ranking of asset class returns.  I got an insightful comment there from another blogger by the name of Coach Carson, who focuses on real estate investing.  In my post, I noted that, since the 1970s, real estate consistently ranked as one of the worst-performing assets in terms of annual returns as compared to various types of stocks, government bonds, corporate bonds, and cash.

Two Kinds of Real Estate Investment

Coach Carson noted that the real estate returns I presented only included the price changes of properties over time.  In other words, price-only returns represent investing in something like a primary residence or a vacation property that is never rented out.  Coach Carson wondered how much better real estate might stack up if I included rents in the calculation of real estate returns.  That would be more representative of someone (like him) who regularly invests in rental properties.

We both agreed that the JST Study data, which I’ve used in numerous other posts, was one possible source of historical U.S. real estate returns that includes “imputed” rents.  In this case, imputed means that the researchers couldn’t find enough historical rent data, so they estimated rents based on related data.  I haven’t really used the JST real estate return data much, because accurately imputing country-wide rents back to the turn of the last century seems fraught with many pitfalls.

Real Estate vs. Stocks

In past posts, I’ve considered the extent to which historical rental real estate returns might have exceeded stock and bond returns.  But instead of using imputed rent data, I backed into this question by determining the level of net rents¹ needed to meet or exceed historical stock and bond returns.  Working with data going back to 1963, I found that net annual rent payments of 4% would easily beat 10-year bond returns over the same period.  However, net rents above 6% would be needed to beat the returns of the S&P 500.

Coach Carson’s comment made me realize that I could use the JST Study data as a cross-check on my previous analysis without necessarily fully accepting the accuracy of rents imputed all the way back to 1900.  And conducting the same evaluation in two different ways is often a great way to verify conclusions or identify faulty assumptions.

Historical Rental Real Estate Returns

So, what does the JST Study say about the history of U.S. rental real estate returns?  Here’s a graph comparing the annualized nominal and inflation-adjusted returns (Compound Annual Growth Rate; CAGR) since 1928 for:

• The S&P 500 – using Aswath Damodaran data
• Rental real estate based on price changes only – using Shiller home price data.
• Rental real estate including rents – using JST Study data.

I started the dataset in 1928 because the further back you go, the less applicable the data are to today’s markets and economy.²  According to the JST Study data, the nominal and inflation-adjusted annualized returns of rental real estate have been about 1% less than the S&P 500.  So, not a bad performance for rental real estate, but worse than simple low-cost stock investing.

But that summary reduces the entire data set to investing over one very long period.  Let’s look at how returns performance has varied over time by examining 10-year rolling CAGRs as shown in this graph.

I used 10-year rolling CAGRs because that’s a reasonably mindful investing duration.  With that duration, there were times when the S&P 500 performed better than real estate and other times when the opposite was true.  Even if we only consider real estate price changes (blue line), there were a few times that real estate produced better 10-year returns than the S&P 500.  Conversely, even when we add in imputed rents, there were still many times when the stocks performed better than real estate.  However, the clear ebb and flow of relative performance between the two asset classes suggests that rental real estate is a good long-term diversifier for a stock portfolio.

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I’ve written a few posts about factor investing over the years.  If you’re not familiar with factors, they’re any characteristic of a company or its stock that might have a predictable relationship to that stock’s returns over time.  You can read more about the basics of factors in this post from June 2018.  Some factors have been found to have the potential for increased returns (a so-called “factor premium”) as compared to other segments of the stock market.

But don’t assume that factors are a free ride.  In most cases, factor premiums also involve greater risk in the form of increased routine volatility, and in some cases, factor funds can have higher costs than generic index funds.  Despite these tradeoffs, factor investing is extremely popular because the idea of boosting long-term returns is so seductive.

Quite a few factors have been “discovered” over the years, some of which have more merit than others for reasons I discuss more in my June 2018 post.  Most factors have been discovered by academics using pretty heady statistical methods and datasets that aren’t widely available.  So, imagine my surprise when I stumbled upon my own investing factor just the other day!

Mindfully Investing’s Factor X

I’ll describe my factor in more detail in a moment, but for now, let’s just call it “Factor X”.  I compared the long-term return of $10,000 invested in stocks that meet Factor X criteria to the S&P 500 since 1928 as shown in this graph.

While most of our investing horizons are less than the 93 years shown here, it’s still remarkable that Factor X generated almost $14 million more than investing in the S&P 500.  Expressed another way, Compound Annual Growth Rate (CAGR) or annualized returns represented in the graph are:

• S&P 500 CAGR = 9.79%
• Factor X CAGR = 10.04%

Factor X produced a long-term premium of 0.25% annualized.

Comparing to Established Factors

How does Factor X compare to other factors?  Let’s look at the two most commonly pursued factors: “size” and “value”.  The size factor exists because small-cap stocks have historically outperformed large-cap stocks.  Similarly, the value factor exists because stocks with superior value metrics (things like price-to-book ratio, price-to-earnings ratio, and price-to-free-cash-flow ratio) have outperformed so-called growth stocks with inferior value metrics.

Here’s a similar graph of $10,000 invested in small-cap, large-cap value, large-cap growth, and large-cap stocks starting in 1972, using Portfolio Visualizer data.

In this period, small-caps returned $1.25 million more than large-caps, and large-cap value returned $380,000 more than large-cap growth.  Again, that sounds pretty impressive, but let’s look at the annualized returns (CAGR) over this same timespan:

• Small-cap CAGR = 12.08%
• Large-cap value CAGR = 11.37%
• Large-cap growth CAGR =  10.91%
• Large-cap CAGR = 10.75%

Since 1972, the annualized small-cap premium has been 1.33%, and the large-cap value premium has been 0.45%.  So, the long-term Factor X premium since 1928 was about one-fifth of the small-cap premium and half of the large-cap value premium.

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