Time to Get Real: Why the Stock Market Can’t Be a 15% Vending Machine Forever
John: Hi everyone, and welcome back to the blog! If you’ve peeked at your retirement account or just watched the news over the past decade or so, you might have noticed something pretty amazing. The U.S. stock market has been on an incredible hot streak. It’s been like a star basketball player who just can’t seem to miss a shot.
Lila: It’s true, John! I see headlines all the time about how well stocks are doing. It almost feels like you can just put money in and it’s guaranteed to grow by a huge amount every year.
John: That’s a very common feeling, Lila! And it’s easy to see why. Since the end of the big financial crisis back in 2009, the S&P 500—which is a common way to measure the overall U.S. stock market—has returned an average of about 15.5% per year! That’s a spectacular number. But it leads us to a really important question: Can this last forever? Today, we’re going to break down why the answer is almost certainly “no,” and why that’s actually okay.
The Secret Recipe for Stock Market Returns
John: First things first, it’s helpful to know where stock market returns actually come from. It’s not magic; it’s more like a recipe with a few key ingredients. For any stock, or the market as a whole, the returns you get are a combination of three things:
- Business Growth (Earnings): This is the most straightforward part. When you own a stock, you own a tiny piece of a real business. If that business sells more products, improves its services, and makes more profit, your piece of the company becomes more valuable. This is called earnings growth.
- Dividends: Some companies take a portion of their profits and give it directly back to their shareholders. Think of it as a “thank you” bonus for being an owner. It’s a direct cash payment to you.
- Change in Sentiment (Valuation): This one is a bit trickier. It’s about how much other people are willing to pay for the same stock. It’s the “hype” or “popularity” factor.
Lila: Hold on, John. “Valuation” sounds a little technical. What does that really mean in simple terms?
John: Great question, Lila! Think of it like buying a house. The house has a certain value based on its size, location, and condition. That’s like the company’s earnings. But the final price you pay also depends on how popular the neighborhood is. If everyone suddenly wants to live there, prices get bid up, even if the houses themselves haven’t changed. That’s a change in valuation. In the stock market, we often measure this with something called the P/E ratio.
Lila: P/E ratio? Uh oh, more jargon!
John: I promise it’s simple! P/E stands for Price-to-Earnings. Let’s use a lemonade stand as an example.
Imagine a lemonade stand makes $100 in profit (that’s its “Earnings”) in a year. If you buy the whole stand for a price of $1,500, its P/E ratio is 15 ($1,500 Price / $100 Earnings). You paid 15 times its annual profit.
If the next year, the stand still makes $100, but it becomes famous and someone offers to buy it from you for $2,000, the P/E ratio is now 20. The business itself didn’t make more money, but people’s feelings—the valuation—changed. They were willing to pay more for the same amount of profit.
So, What Fueled Our Recent 15% Rocket Ship?
John: Now that we know the recipe, let’s look at that incredible 15.5% annual return we’ve seen since 2009. Where did it come from?
- About 6% of it came from companies actually making more money (earnings growth).
- About 2% of it came from dividends.
- That leaves a whopping 7.5% that came from that third ingredient: valuations going up.
Lila: Wow, so about half of the amazing returns we’ve seen came from that “hype” factor you mentioned? People just becoming willing to pay more and more for stocks?
John: Exactly! The P/E ratio for the overall market has stretched a lot. In 2009, people were scared and valuations were low. Over the next 15 years, confidence returned and grew, and people were willing to pay higher and higher prices for every dollar of a company’s earnings. That gave our investment returns a massive, massive boost.
Why the Hype Train Has to Slow Down
John: This brings us to the main point. That 7.5% boost from rising valuations is not normal, and it can’t go on forever. It’s the financial equivalent of stretching a rubber band. You can stretch it pretty far, but at some point, it either stops stretching or it snaps back.
Lila: You mean the P/E ratio can’t just keep going up and up indefinitely?
John: Precisely. Let’s go back to our lemonade stand. It makes $100 a year. You bought it when its P/E was 15 (a price of $1,500). Then it went up to a P/E of 20 (a price of $2,000). Maybe next year it goes to 25, then 30. But would someone eventually pay a P/E of 100, meaning a price of $10,000 for a business that only earns $100 a year? It becomes illogical. At some point, investors demand that the price they pay has a reasonable connection to the profit the business actually generates.
Because valuations are already quite high today compared to history, it’s very unlikely they will continue to expand at the same rate. In fact, it’s more likely that over the next decade, this part of the recipe will contribute zero to our returns, or even be a negative number if valuations shrink back to more average levels.
Setting Realistic Expectations for the Future
John: So if we can’t count on that “hype” factor to boost our returns, what should we expect going forward? Let’s look at the very long-term history of the stock market, going back nearly 100 years. The average annual return has been closer to 10%.
Here’s how that historical 10% breaks down:
- Earnings Growth: Around 6-7% per year. Businesses, on average, tend to grow their profits a little faster than the overall economy.
- Dividends: Around 3-4% per year.
- Valuation Changes: Close to 0%. Over the very long run, the periods of hype (when P/E ratios expand) and periods of fear (when they shrink) tend to cancel each other out.
Lila: So, a 10% return is what we should consider “normal,” not 15%?
John: That’s a much more realistic and healthy expectation for long-term planning. And let’s be clear: a 10% average annual return is still fantastic! It’s a powerful engine for building wealth over time. The danger isn’t that returns will be lower; the danger is expecting the extraordinary returns of the last 15 years to be the new normal. Basing your financial future on a 15% return is like a farmer planning his budget based on a once-in-a-century harvest. It’s better to plan for a good, normal year.
Our Final Thoughts
John: For me, this is a powerful lesson in perspective. It’s easy to get caught up in the excitement when markets are soaring. But true investing success comes from understanding the fundamentals and having realistic expectations. Planning for 10% and being pleasantly surprised by a 15% year is a great position to be in. Planning for 15% and being disappointed by 10% can lead to panic and bad decisions.
Lila: This makes so much sense now. I really did think those huge numbers were normal. Understanding that returns are tied to real things, like a company’s actual profits, makes investing feel less like a casino and more like a long-term partnership with businesses. It’s a good reminder to stay calm and focus on the long game, not just the last few amazing years.
This article is based on the following original source, summarized from the author’s perspective:
Why Can’t the Stock Market Grow at 15% Forever?