I recently read the “The Little Book of Value Investing” by Christopher H. Browne over the holidays and thoroughly enjoyed it. One passage of the book in particular caught my eye for its simplest explanation of the 10% historical return of the S&P 500 index, and I thought I should share it with you. You can find the following quote on the page 20 of this book.
"If you think the Standard & Poor’s 500 stock index as a giant conglomerate with 500 divisions, you will observe that over long periods, its earnings have grown on average about 6 percent per year. Typically, 3 percent of the increase has come from the growth of Gross National Product, and 3 percent has come from inflation. Therefore, the intrinsic value of the S&P 500 thought of a single company increases about 6 percent a year. In addition, the S&P 500 pays a dividend. Historically, the dividend yield of the S&P 500 has been in the range of 3 percent to 4 percent. Take the sum of the long term earnings growth (6 percent) and the dividend yield (4 percent), and you get a long-term annually compounded rate of return for the S&P 500 of about 10 percent. This is the return investors in an index fund expect to make over the long term. And if they stay in the index fund long enough, they should get that return."