First, the objective of this exercise: to focus you to think long term and realize the power of compounding. Nothing new here, but when you do a few extrapolations, the numbers may amaze your perspective.
Second, the facts: the Dow has returned about 8% historically since 1928.
I crunched DJIA data from 1928 through 2007 during which it has gone from 300 to 14,000 (chart 1).
The annualized rate of return has varied based on the time span you use, as you can see in the chart below, but it is about 8% for the 80 year period. And that’s conservative. The annual returns for the post-war period are more like 12%.
The S&P has also returned an annualized 8% for the past 57 years, and a little over 5% (annualized) for the past 100.
Third, the assumptions: this is where it gets tricky. Agreed that past performance is no guarantee of future results, but the idea of taking large spans of time for the returns above was to smoothen out short term volatilities, depressions, recessions, irrational exuberances, boom and busts etc. You get the idea. Also (being the optimist that I am), I have assumed that we – as in mankind – don’t nuclear-wipe ourselves out or choke the planet. And if we hit the Singularity in 2050, then all bets are off.
So I am going to assume that the market will return a conservative 8% over the next couple of decades. Put another way, it means that the Dow will double every 9 years. Ah ha! With me so far?
The rest is merely extrapolation. Starting with a 14000 Dow in 2008, you can see below that the Dow will hit a million by 2064 (at the risk of dating my son, he will retire in 2070)! But wait, go out a bit more and you have a 10 million Dow by 2094. (chart below)
Do you think this curve is irrationally steep? I thought so too. So I put the past and future 80 year periods on the same chart with a log scale. Now do the next 80 years look like the past (chart below)?
So what do I recommend? Invest periodically with a discipline (don’t try to time the market), and be in there for the long term (as far as you can afford to). Even if you are a passive investor in a Dow or S&P ETF, you will do fine in the long run. And, if I am not wrong, stocks have historically returned more than real estate. Now you may sleep better too.
Disclaimer: the author is “long” the market
