What Determines the Return on Stocks?
The return on a stock investment is determined by a large number of factors that also influence each other. Below, we list the most important factors.
The Success of a Company
In the long term, your return grows along with the success of the companies you invest in. If these companies make profits and continue to grow, the stock prices and usually also the profit distributions (dividends) of these companies increase.
Macroeconomic Factors
Macroeconomic factors play a major role in the short-term development of stock prices. The development of interest rates is such a factor, or economic growth in a country or region. These factors influence the profitability or growth opportunities of companies, a region, or a sector.
Sentiment
In the short term, emotions, news, and expectations play a big role in the stock market. A company can achieve good results while its stock price falls or vice versa, for example due to economic or geopolitical news such as new American import tariffs or developments in the war in Ukraine.
Time
The longer you invest, the greater the chance that you’ll achieve a good return. The main reason is that the long-term trend of the stock markets has been upward for decades. There have been peaks and troughs in between, but in the long run, these practically disappear.
Additionally, in the long term, you have the effect of compound interest (also called compound growth). It works like a rolling snowball: you make a return again this year on the profit you made last year. This effect is enormous.
Historically, stocks have shown an average positive return of around 8%. Suppose you had invested €1,000 on day 1, with an average return of 8%, you would have an amount of €2,160 at the end of year 10.
Risk
Investing in a single company or sector is risky. A high risk is potentially offset by a very high return or a very large loss. If things go well, you can achieve a fantastic return, and if things really go wrong, you lose everything.
If you invest in stocks of multiple companies, these kinds of extreme outcomes are unlikely to occur.
Costs
The fewer costs you pay, the more return you keep. In the long run, this makes a big difference, and that’s due to the snowball effect of compound interest (see also the previous paragraph “time”). If your costs are lower and your return is therefore higher, that rolling snowball grows quickly.
An example. Suppose you pay 2% costs per year, and you had invested €1,000 on day 1 and made 8% return before costs, then after 10 years you’ll have €1,790 left and your profit is €790. If those costs were 0.5%, then after 10 years you’d have €2,060 and your profit would be €1,060. That’s more than a third more.
