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Is it realistic to expect a 12% long-term return?Reprinted courtesy of MarketWatch.com.

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In 1999 and early 2000, when the stock market was going gangbusters under the leadership of technology stocks, many investors believed double-digit returns were a given.

Multiple surveys indicated that investors expected annual gains of 20% to 30% in the first decade of this century — even though the stock market had never experienced such sustained returns in the past.

When I suggested these expectations were unreasonable, some readers scoffed at my old-fashioned attitude. Such is the power of recent performance on investor psychology. Investors find it easy to ignore the long-term past. Instead, they assume that recent performance is “the new normal.”

Those optimistic expectations from the turn of the century didn’t pan out. Since 1999, the S&P 500 has compounded at 4.1%. The Nasdaq Index in that same period has compounded at only 2.2%.

Now, 16 years later, I have come under attack for suggesting that very-long-term returns of at least 12% are possible. Even some people in my family seem to think this is a mere fantasy.

Once, again, recent performance trumps long-term history, only in the opposite direction. Whatever you want to believe is up to you. I see my job as giving you the facts so you can make up your own mind.

My recent assertions were not meant to suggest a return to double-digit gains any time soon, although they are certainly possible. Instead, I’ve been thinking and writing about what returns might be possible over many decades, perhaps even a 95-year lifetime of a child born today.

So let’s look at some factual history.

In all of the 50-calendar-year periods going back to 1928, the S&P 500 had a compound return, on average, of 11%.

This suggests to me that 10% is a historically reasonable long-term expectation for the S&P 500. It won’t get there every year or every decade, but over a lifetime I think 10% is quite possible.

As you may know, the S&P 500 is expected to have the lowest long-term returns of all four major U.S. equity asset classes. (The others are large-cap value, small-cap blend and small-cap value.) In the past, this expectation has been fulfilled.

Now here’s another fact: Academic experts believe that over time, small-cap stocks as an asset class should have an advantage of 1% to 2% over the S&P 500, and value stocks should have an advantage of 2% to 3%.

That’s the theory. Let’s look at the reality.

In all 38 of the 50-year periods starting in 1928, not once did the S&P 500 outperform any of those other major U.S. asset classes.

Large-cap value: On average, its compound return over 50-year periods was 13.5%. In its worst 50 years, this asset class compounded at 8.8%. (For the S&P 500, the worst half-century was 7.7%.)

Small-cap blend: On average, its compound return over 50-year periods was 13.8%. In its worst 50 years, this asset class compounded at 10.9%.

Small-cap value: On average, the 50-year compound return was 16.3%, an enormous improvement over the S&P 500. Small-cap value’s worst 50 years resulted in a compound return of 11.1%.

As you may recall, what got me into hot water recently was my opinion that 12%, over a lifetime, is a reasonable expectation for small-cap value stocks. I still believe that, and now you know some of the history behind my belief.

It should be noted that all of these figures would be lower if commissions, management fees, taxes and inflation were taken into consideration. That can’t be helped, though there are of course ways to minimize fees and taxes.

What’s most important here is the big difference, measured over many decades, in the returns of small-cap value stocks.

Investors who focus on bonds more than on stocks may be interested to know what happened to fixed-income over all these 50-year periods.

Long-term corporate bonds, on average, compounded at 5.1% in these 50-year periods. The worst 50 years was a compound return of 2.8%.

U.S. Treasury Bills, on average, compounded at 5.4%. Their worst 50 years was a compound rate of 2.4%
I don’t expect the future to be like the past. But I’d like you to recall that the very-long-term data I’ve presented came in a period that included an all-out world war, a prolonged cold war between two superpower governments, and numerous smaller wars, some declared, some not.

In addition there were all sorts of national and regional uprisings. This period included natural disasters, political scandals, a prolonged worldwide depression, serious inflation, numerous serious recessions, great social changes and more additional challenges than I care to think about.

Throughout all these events, trends, changes and upheavals, the U.S. stock market turned in double-digit long-term returns.

Obviously, no investor has any right to count on a particular outcome in the future. But based on all the evidence I have, I believe small-cap value stocks have a quite reasonable probability of compounding at a rate of at least 12% over the next 50 to 100 years.

I wouldn’t bet my entire future on that. But I think it’s a strong enough possibility to be worthwhile for a “gift of a lifetime” to a newborn child or grandchild.

For more on this topic, check out my podcast “12 simple steps to getting 12%.”

Richard Buck contributed to this article.