The great stock myth

I was doing some research the other day and I found out something really interesting. All these years I've been hearing that stocks provide a great rate of return, with the Dow Jones averagine something like a 7% rate of return since its inception. While this isn't the astronomical level that we'd all like, I've found out that it's actually an "inflated" number.


By inflated, I mean that the Dow Jones has been growing at an anualized rate less than 7% over its history. By my calculations the Dow Jones grew at a rate of 5.457% over the first 105 years of its existence.


To understand the discrepency all you have to do is think about how average affects the rate of return. Consider an investment over ten years. For simplicity we'll assume that your investment never depreciates on an anual basis, i.e. growth will be non-negative. If you average a rate of return of 5%, you will have at a minimum of of 150% of your initial investment (50% one year, 0% the rest). On the other hand if you earn 5% every year you'll have 163% of your initial investment.


Given that the "classic" index only yeilds about 5.5% over the long haul, wouldn't it be more prudent (for the naive long term investor) to put your money 30 year T-Bonds where you can -- even today -- get a yeild in excess of 5%?


- Andrew