Can You Count on 10% Returns?

You know the drill -- the stock market's average annual return has been around 10% for many decades. In fact, here are some stats from business professor Jeremy Siegel:

Source: Stocks for the Long Run, Jeremy Siegel.

The past couple of years have brought those averages down a bit, but that's not the primary objection I've heard. Rather, I've run across some occasional grumbling that these numbers are simply misleading, and that just because stocks have done well over certain periods of time doesn't mean they will over your or my lifetime.

Well, it's true that you won't always get a return that's close to 10%. In fact, as my colleague Richard Gibbons has pointed out, in the 40-year period ending in February 2009, the stock market averaged just 5.3%, and bonds outperformed stocks.

Convincing numbers
Yet while bonds can beat stocks from time to time, even over longer periods, it's important to realize that they usually haven't. Check out these statistics from Siegel, reflecting how often stocks outperformed bonds over various rolling periods between 1871 and 2006:

Source: Stocks for the Long Run, Jeremy Siegel.

Again, with bonds having done better than stocks since 2006, those numbers are probably a little lower now. But even so, stocks often beat out bonds even over short periods. And they do so much more frequently the longer you invest.

What to do
So do consider favoring stocks heavily in your investing, but also know that you should not expect 10% as your ultimate average return. Over your particular investing time frame, you might average 5% or 15% -- or, most likely, something else. Still, since stocks seem to offer great odds of outperforming other investments, you shouldn't just write them off.

Remember, too, that you can easily earn the market's return by investing in a simple index fund -- or you may beat that 10% handily by choosing some exceptional individual stocks for your portfolio. Check out these 20-year average returns, for example:

Sources: Motley Fool CAPS, Yahoo! Finance.

Of course, again, remember that returns like the ones above are not to be expected from most stocks. You have to choose well, and you're bound to end up with some stinkers. Investors in Eastman Kodak over the past two decades, for example, have seen their investment lose about three-quarters of its value.

Bonds and more
Despite my advocacy of stocks, I do think there's a place in portfolios for bonds -- especially as we age and get closer to (and enter) retirement. In our Rule Your Retirement newsletter, for instance, Fool retirement expert Robert Brokamp has laid out a model portfolio allocation, calling for a steadily rising role for bonds to play as you approach and enter retirement. By adding in more bonds, the portfolio is exposed to less risk and should prove less volatile in the face of strong market fluctuations or even a meltdown.

Finally, as you aim to earn that 10% annual average, or to beat it, consider having at least a handful of substantial dividend payers in your portfolio. That's because even when the market stalls or falls, if you've chosen healthy dividend payers, they'll keep paying you. Over time, a huge amount of the total return you earn comes not from stock prices going up but rather from the dividends your stocks pay you.

So go forth and invest -- and continue to aim to meet or beat that 10% historical average annual return. Just don't rely on it. You may do better or worse. But you can up your odds of doing well by focusing on stocks and adding bonds as you age, and by keeping some dividend payers as well.