9% annual return is the goal, but why?

Investing can be an incredibly overwhelming task, especially when you are new to the world of finance.  People often talk about the importance of returns or how to measure the success of an investment.  Oftentimes, you might hear someone reference their investment returning high or lower than an annual return of 9%.  But why do they specifically say that 9%?  Seems kind of arbitrary, right?  It turns out that there is a method to the madness and today we will explore why you often hear that 9% being talked about as a benchmark for evaluating the success of an investment. 

First, when you invest your money, you are basically purchasing a share of a company or a group of companies through a mutual fund or index fund.  But why are you investing?  You are investing because you want to make your money grow over time.  The measure of this growth, over a period, is known as the return.  Returns can be measured in many ways, but one of the most common measurements is the annualized return.  This is the average rate of return over a specific period annualized to calculate how much that return is over a year.

So why do we use 9% as a baseline for investment performance?  The answer comes from the historical performance of the stock market.  The S&P 500 index is an index that tracks the performance of 500 large publicly traded companies in the United States has delivered an average rate of return of about 9-10%, adjusted for inflation, over a long period of time.  This means that if you invested in the S&P 500 long ago, you could have expected to earn an average rate of return of about 9-10%. 

This is very important to highlight – past performance is not indicative of future performance.  How the market has performed in the past does not guarantee that it will perform that way in the future or present.  The stock market is volatile and can be affected by various factors, such as recessions, geopolitical events, or company specific news.  Therefore, a 9% annual return can be a helpful benchmark or baseline to judge an investment, but it should never be taken as a guarantee of future returns. 

Let’s look at a quick example because using 9% can be a helpful tool when someone is evaluating investment performance.  Suppose I invested $100 in a mutual fund with an average annual return of 7% over the past five years.  Can I look at that investment and determine whether or not that is a good investment?  Well, it would depend.  If I compare that to the 9% annual return of the S&P 500, it might seem like a subpar performance.  However, if that mutual fund had a lower risk and volatility than the S&P 500 over that period, the 7% annual return might be more attractive to me.  This is because obviously risk and volatility can affect any investment and some years might be up significantly others might be down significantly with an average close to about 9%.  Some people might look at the risk and volatility as a negative factor of an investment and want to choose the safer option offering a lower percentage return.  This is why it is very important to assess your risk tolerance and consult with financial professionals before investing your own money. 

Using 9% as a baseline can be a great benchmark for setting investment goals.  For example, you might have heard that real estate returns often crush the 9% returns of the stock market.  If you have a goal to earn 12% of your money, investing in real estate might be the investment for you.  There are other security options too, I just mention real estate because it is another investment medium that you can use to calculate a fairly accurate return – after you get skilled enough in analyzing properties, of course.  But let’s take another hypothetical security analysis example, suppose I have 30 years until I retire, it is reasonable for me to use that 9% return as a baseline for how much my money could potentially grow.  Of course, actual returns will vary from that 9% because downturns happen, life gets in the way, etc.  but it is a helpful tool to use as a goal when someone starts investing.   

Additionally, 9% is not the only benchmark used by investors.  Some investors might select a different return baseline based on their own strategy or goals.  For example, a conservative investor might want to use 5-6% as an annual return or perhaps an aggressive investor might want to use 12-15% as a benchmark for their annual return.  It is important to select a goal that is not only suitable for you, but appropriate enough based on your own risk tolerance and experience, along with the help from a financial professional.  In fact, a financial professional could give you a more detailed analysis using various rates of return and how they’ve performed in their own actively managed funds.  It would be very helpful to find someone in your area to discuss this with, the point of this post is to highlight why people use 9% as an annual return goal or why you might have heard then when someone has judged the success of their or another investment. 

So there you have it.  A brief discussion about why we use 9% annual returns as a common baseline.  It is just how the market has performed over time, on average.  Some years are good, other years are bad.  This should not be used as financial advice because past performance will never guarantee future results.  However, it is helpful to use when analyzing your own portfolio or a potential investment.  Consider your own risk tolerance, investment goals, and market conditions when selecting a benchmark.  Discuss this with a financial professional in your area and regularly review your investment portfolio as needed.