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I invest in the S&P 500 from the UK.

I am trying to calculate what my investment pot will be in 25 years, adjusting for inflation.

Unfortunately, my calculations point me towards an abysmal inflation-adjusted return of 1.26% -- I must be doing something wrong.

I have taken historical data from 1928 to 2020 from Yahoo Finance and Bank of England:

S&P 500 Average Return (Since 1928):

5.87% (17.57 climbs to 3,329.67 over 92 years)

GBP Average Inflation (Since 1928):

4.61% (£63.29 erodes to £1 over 92 years)

S&P 500 Return (UK Inflation Adjusted):

1.26% (5.87% - 4.61%)

Illustrative example:

If I wanted to retire in 25 years time, with £1,000,000 in my pension, I would need £740,000 today... I must have done something wrong here!

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    As per @WerKater's answers below, the 5.87% return excludes dividends. For the same period, including dividends, the return of the S&P 500 was 9.9%, giving me a 5.29% return. Much better!
    – Lawrence Wagerfield
    Jan 19 '20 at 11:12
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    If I understand your post correctly, you are calculating returns in GBP as you go, but the S&P 500 is in USD. So you should instead calculate the return in USD, and then convert to GBP whenever you take money out. The basic problem with using historic data is that the British devalued the pound a lot relative to the dollar.
    – jamesqf
    Jan 19 '20 at 17:54
  • @jamesqf I am using a GBP-hedged tracker: I therefore receive the same returns in my own currency as I would if I were investing in a regular tracker with USD.
    – Lawrence Wagerfield
    Feb 1 '20 at 20:20
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The S&P 500 does not include dividends. You should check the S&P 500 Total Return Index.

From Wikipedia:

The average annual total return of the index, including dividends, since inception in 1926 has been 9.8%

This would give you roughly 5.2% annual real return, looking much better.

However, this is in USD. Apparently, one GPB was worth roughly 5 USD in 1926 and is now worth about 1.3USD. (Note: I am trying to read the values from the chart, maybe somebody has more precise values?)

Hence, your USD denominated S&P 500 would today buy 5/1.3=3.8 more GBP, giving you a total return in GBP of 11.4% nominal (6.8% real) if my quick math is right.

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  • I don’t think your quick maths is right, because you’re calculating the real returns using the same average inflation rate for the GBP as you used for the USD, which can’t be right.
    – Mike Scott
    Jan 19 '20 at 9:48
  • The total return index! Thank you, this is what I was missing :D Re. GBPUSD: I used a GBP-hedged ETF, so the currency conversion doesn't play into it (fortunately!)
    – Lawrence Wagerfield
    Jan 19 '20 at 11:11
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    @Mike Scott: I think ym approach is correct, at least fundamentally: OP has 1000GBP in 1926. Those buy him 5000USD. He invests into S&P 500, money grows to 5,000 USD*(1+9.8%)^92 = 27,189,000USD. He converts back to GBP, giving him 27,189,000/1.3 = 20,915,000GBP. Total increase factor: 20,915,000/1,000 = 20,915 Annualized nominal return: 20,915^(1/92)-1 = 11.4% Now we must simply subtract his local inflation rate to get the real return. USD inflation never comes into it, except in that it has probably influenced the conversion rates.
    – WerKater
    Jan 19 '20 at 11:52
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I am trying to calculate what my investment pot will be in 25 years, adjusting for inflation.

You should really be looking at estimated future returns, not historical returns.

The stock return will consist of three components:

  • Inflation. Stocks are inherently inflation-protected, so whatever inflation there will be will be part of your return.
  • Economic growth. Stocks are investments into companies that are running a good fraction of the world economy.
  • Dividends. Stocks pay dividend and it will directly benefit you.

Global economic growth in the near future (2030) is projected to be bit below 4%. However, US economic growth is lower. Then again, most companies in S&P 500 are global companies benefiting from economic growth wherever it happens, so the best estimate for economic growth component is between US growth (around 2%) and global growth (bit below 4%). I would say 3% is a good estimate.

Dividend yield of S&P 500 is 2% currently. However, some companies do share buybacks so you should take those into account as positive dividends. On the other hand, some companies issue new shares, collecting money from the investors, so you should take those into account as negative dividends. I would assume the share buybacks and issues of new shares cancel each other out, so 2% dividends is reasonable.

Inflation target in most areas is 2% (EU, US). This is the best estimate for long-term inflation.

So, you can assume your returns are 3%+2%+2% = 7% if investing to the US stock market. You must subtract the costs of investing and taxes from this pre-cost+pre-tax return.

Another way to take a look at the returns: corporate earnings are turned into two components: economic growth and dividends. Inflation is a component taken separately into account. Thus, the return can be estimated to be E/P + inflation. S&P 500 P/E ratio currently is 25, so E/P ratio is 4%. This would give you a return of 4% + 2% = 6%.

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