People assume all sorts of wild stock market returns when they make their financial calculations. Here are some numbers that show up on web searches:

6 %

8.4 %

10 %

10.1 %

11.3 %

11.5 %

13.6 %

16 %

These are all correctly computed under their respective assumptions, but they are very misleading because whatever those assumptions were, they’re not relevant for most calculations. You should assume 4 % in your calculations. Here’s one way to arrive at that:

• The S&P 500 has historically yielded 12 % per year before inflation.
• But that’s the arithmetic mean. Returns compound geometrically, so what we actually want is the compound annual growth rate. The typical rule of thumb is to remove half the squared volatility from the arithmetic mean. Volatility is notoriously hard to estimate, but let’s put it at 15–30 %. This leaves us with a cagr of 8–11 %.
• During the same period, inflation has been 3–4 % depending on which source you trust. This brings the real (inflation-adjusted) returns down to 4–8 %.
• On top of that, we have holding costs, transaction costs (e.g. rebalancing), and taxes. These are different in different localities and vary by investment strategy, but let’s say they remove 1–3 % of return. The net cagr is, then, 2–6 %.

In the middle of all our assumptions we find 4 %. That’s a much more reasonable number.