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Compound Interest Week: Real Interest Rates of the Stock Market

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Yesterday we learned that the real interest rate of return on high-interest savings accounts is low - a really low 2%. We found that it would take 35 years for money to double at that percentage.

Today, I'd like to look at real interest rates of the stock market. I used to say that the stock market returns 8-10% annually, but I've seen some recent data that for some significantly long time spans, it returns around 12%. I'm not quite ready to work with 12% numbers, but I'm thinking the 10% number is pretty reasonable for this exercise.

Using that 10% as the return of stock market, the real return (after inflation) on a stock market investment is around 6.9%. Going back to our doubling chart we find that your money would double around every 10 years. This is a great advantage over the 70 years that it would take in a high-interest savings account. For example, $10,000 in the high-interest savings account will turn to $40,000 in 70 years (doubling once at $20,000 after 35 years and again at 70). However, at the nearly 7% growth of the market, $10,000 would grow to nearly $1.28 million dollars. There's a little rounding in this math, but the numbers still show that you'd have over 1 million dollars more in buying power by just making this small financial decision.

On a side note, I'm looking to make a 10% real rate of return on my lending in Prosper.com. I'm not currently doing that well. I hope that is due to the mistakes I made during my learning curve. With the tools that I have found, I believe that I'm closer to that goal.

Posted on May 10, 2007.

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Investing

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3 Responses to “Compound Interest Week: Real Interest Rates of the Stock Market”

  1. I found the idea and implementation of prosper.com very intriguing. I think want to here a few more lessons learned stories before I would jump in. I also wonder how much time it will take to manage you investment there?

    Thanks for the hard work.
    -The Happy Rock

  2. Lazy Man says:

    Just to leave a couple of sources for the 12% returns see that Vanguard’s S&P 500 has returned 12 % since 1976 (inception) and numbers crunched from JLP of AllFinancialMatters. Note that he later has REAL rate of 9.22%.

    It is only the S&P 500 measured here, not “the market”. However, returns on small caps are supposed to have higher returns than large caps (countless sources say this is true, I don’t have the time/space to go into it hear) and the S&P 500 has just finally got to the point of topping new highs while the Dow has been doing it for some time. This suggests that the largest caps have outperformed the S&P along with the small caps. Thus while the S&P 500 might not be “the market” it stands to reason that it’s in the range of the average market returns. Some things probably perform worse, but there are certainly some things that perform better.

  3. Contrary to belief, we do need recessions every now and then. It’s foolish to think that things can always go up, it will just get you burned in the long run. Good post, really puts things in perspective.

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