Short-term fluctuations in the stock market can easily cause people to lose perspective on the extraordinary wealth ownership in the great companies of the world can create over long periods. Sometimes it helps investors to zoom out and look at the big picture.
1,000% Returns: A Far-Fetched Fantasy?
1,000% return. It sounds like a lot. But to anyone with long-term, historical perspective on stock returns, 1,000% isn’t anything unheard of and is in many ways inevitable. Given a long enough time horizon, as well as the necessary faith, patience, and discipline to stick to your investments for decades, anyone can experience quadruple-digit returns.
As I was discussing this idea with my three sons and my son-in-law (all of whom work with me at Ruedi Wealth Management), they were commenting on what huge wealth something like a 1,000% return could create. It seems like an impossibly large number, but I mentioned that the S&P 500 had probably grown even more than that over their lifetimes.
Don’t believe me? Let’s take a look at the returns they have experienced in their lives:
September 1985 – March 2018
Total Return: 2,861.45%
February 1989 – March 2018
Total Return: 1,572.01%
September 1990 – March 2018
Total Return: 1,358.72%
December 1992 – March 2018
Total Return: 914.48%
Ok, Daniel falls a little bit short. But Ryan, Paul, and David have all been around long enough to have lived through well over a 1,000% return on the S&P 500 Index.
Pretty crazy returns right? Actually, not really. Compound returns over their lifetimes were only slightly above the historical average return of 10.12% for the S&P 500 going back to 1926, and as you can see, returns have been slightly lower since Daniel has been around (but we won’t hold him personally responsible for that).
Let’s not forget, they all lived through the “lost decade” from 2000-2009 where the S&P 500 recorded its worst ever 10-year performance of -9.1%, which included dividends. This accounts for a good 1/3 of their lives or more!
Shocked? You Shouldn’t Be
The reason seemingly huge returns like this are not surprising to me is the simple math of compounding – and as the simplest explanations tend to be the best, we will use the rule of 72 for a simple example.
If you didn’t have to take a finance course, you may not have heard of the rule of 72. The rule is a “back of the envelope” calculation for investors to quickly get a sense of how quickly their money doubles provided a certain interest rate. So if your rate of return was 5%: 72/5 = 14.4 - It takes roughly 14.4 years for your money to double. If your interest rate is 2%: 72/2 = 36 years for your money to double.
This math makes it easy to see why the stock market can generate seemingly astronomical returns over long periods of time. It simply has the time to double, and double again, and so on, and so on. You can understand how the numbers can get very large, very fast.
As we mentioned before, the return on the S&P 500 was about 10% in the time periods above – nothing unusually high from a historical perspective. That means every 7.2 years or so, an investment in the S&P 500 roughly doubled.
Paul Jr. at age 29 – very convenient for our math - has been around long enough for that doubling to take place roughly 4 times. So one dollar invested at his birth went from 2, then 4, then 8, then 16! If you look at the return numbers above, that is a pretty good approximation of what happened.
So why doesn’t Daniel have a lifetime return over 1,000%? Simply put, he hasn’t lived long enough. But given a few more years I’m sure he too will join the “1,000% club.”
Earn Your Return
If it is so easy to earn the returns above why doesn’t everyone do it? Well to be fair, investors over this time period really did “earn” their return, as they had to weather some serious temporary declines and several full-blown financial crises.
Ryan arrived in this world two years before Black Monday (10/19/1987), when the Dow Jones dropped nearly 22% in one day. All four lived through the tech bubble bursting in 2000. They all lived through the 2008 financial crisis and the “lost decade”.
A lot of people did not stick with their stock investments during those times and missed out on the market returns that were there for the taking had they simply remained in their seats.
This is the premium risk you must not only accept, but embrace as the driver of the premium returns we have seen from the great companies of the world over time. You must understand that this is the deal going into it, and commit yourself to a long-term investment strategy where success is measured over decades, not years. You have to have the faith, patience, and discipline to stick with your investments. If you do, the results are nothing short of extraordinary.
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Disclaimer: Examples are for illustrative purposes only and should not be viewed as an investment recommendation. Past performance is not an indicator of future results.
Performance data taken from Dimensional Returns 2.0. All returns numbers are based on monthly returns. Indexes are not available for direct investment and the returns data provided is for educational purposes only.