Excerpted from Common Sense on Mutual Funds by John C. Bogle, pages 7-9

In discussing the total returns on common stocks, I refer not to individual equities but to widely diversified equity portfolios. For this purpose I will use the Standard & Poor's 500 Composite Stock Price Index, probably the most accurately constructed of all the myriad indexes of market returns. The returns generated by this diversified index correlate closely with the returns of diversified equity mutual funds.

Before I begin discussing the history of returns on common stocks, I want to emphasize that stock returns are driven by two critical factors: dividends and earnings. Without dividends, which are made possible by earnings, an investment in any stock would be purely speculative in nature. Why are dividends and earnings so vital to stock returns? The most basic way to answer that question is to recall that a share of company stock represents a share in a business firm. If you are considering purchasing shares in a firm, you have two broad expectations for that firm: (1) it will pay annual dividends and the amount of these dividends will grow over time; or (2) rather than paying dividends, it will retain its earnings so as to build the business.

While the second expectation suggests that dividends need not always be a critical determinant of the returns on stocks, even when a company does not pay a dividend investors implicitly value the firm's stock based on the presumption of future dividends. When the earnings of a business are retained each year, investors expect that the earnings will increase over time, resulting in future dividends that will be higher than if they had been distributed currently. In sum, while the consideration of stock returns may encompass any number of qualitative and quantitative factors, any valuation judgment must ultimately rely on dividends and earnings.

YAHOO! FINANCE TIP Yahoo! Finance reports a company's dividend and earnings data on its key statistics page. For an example, see GE's key statistics page.

Since 1926, the average annual total return (taking into account both capital appreciation and dividends) on common stocks has been +10.3%. While it is important to know what to expect from the stock market in the long run, you should also consider how stock returns have varied over different periods. Since this book is addressed to the long-term investor, I use a decade as my standard for analysis. Figure 1-2 shows the annualized total return on common stocks for the average decade during the 67-year period ended December 31, 1992, and for each of the 58 "moving decades" within it (1925-35, 1926-36, continuing through 1982-92).


As you can see, the variations in total return from one decade to the next were substantial. During the worst decade (1928-38), one of only two with a negative return, stocks provided an average annual return of -0.9%. During the best decade (1948-58), the average annual return was +20.1%. Nine decades witnessed returns of less than +5% and 16 of more than +15%. The majority, 33 decades, were in a middle range of +5% to +15%. If you had put your money to work at the beginning of any particular decade, there would have been roughly a 50-50 chance that your return would have been better than the +10.5% decade norm and a 50-50 chance that it would have been worse.