It’s easy to think about the stock market like it’s a retirement program. That’s certainly how it seems to function as you save toward that goal. Typically you’ve accumulated a lump sum and/or set up an automated contribution to your portfolio and are following a disciplined plan with the end goal of having a nest egg of sufficient size to replace your current income at some point in the future.

That’s certainly how it appears to the investor saving for retirement. But that’s not why the stock market exists or how it functions.

The market was created as an efficient way to provide capital for business. If a company can access money over and above what they are bringing in through current activity, it can pursue opportunities to expand operations, innovate their products, and potentially increase profits.

One way to get this expansion money is to borrow it from a bank. And most businesses do have a bank line of credit. But for a variety of reasons, including cost, companies will seek to tap into the financial markets by offering investors a fractional ownership stake in their business (stocks) or a lending position in their debt (bonds).

While investors are buying stocks or bonds in the market to get a return on their money, the enterprises they’re investing in are selling those securities to get capital. So, while publicly held companies want good returns for their shareholders, a huge jump in their stock price means that their future investors will eventually seek the same premium. And this tends to make a repetition of extraordinary gains less likely.

Marlena Lee, PhD and Wes Crill, PhD, senior investment executives at Dimensional funds give this example: The (so called) Magnificent 7 stocks grew by 76% in 2023. But is this a reasonable cost of equity capital? If these companies can secure funding at a lower rate through other means, they will. Which means that 76% is not likely to be a reasonable expected rate of return in the future.1

In other words, when a stock’s price is driven up by short-term investors who are hoping not to miss out on the next big thing, they are creating the conditions for that stock’s eventual decline. Because a stock is traded within a market for capital, it will tend to revert to market rates for that capital. For reference, across a century, the broad U.S. market has posted annualized returns averaging around 10%.

Given this tendency, Lee and Crill advise, “Rather than trying to guess which stocks might provide next year’s outsized returns, or getting caught up in a cycle of fear and greed, we believe it is better to set reasonable long-term expectations to track progress toward your financial goals.”

Setting your expectations on an extraordinary outcome that is less likely to reoccur can lead to disappointment and frustration. Given your investing timeline, your risk tolerance, and your unique financial situation, your trusted advisor can help you determine what that reasonable expectation should be.