The genius of hindsight is a delicious tool. Mr. Raskob probably had no idea what sort of rate of return his hypothetical young man was actually earning. It should be remembered in this era of spreadsheets and $20 handheld financial calculators that the computation of an internal rate of return is a formidable task using only pencil and paper. In fact, our young man was quite an investment genius -- turning 15 dollars per month into $80,000 over 20 years requires an annualized rate of return of about 26 percent! Perhaps in 1929 a 26% annualized rate of return did not seem unreasonable. It was not until the aftermath of the 1929-32 market catastrophe that the long term return of common stocks was estimated with any accuracy. In 1996 most serious investors are aware that one cannot expect more than about 10%-12% long term.
This interview, and the investment scheme he was promoting, is remembered to this day as an absurd example of the infectious mood underlying the pre-1929 stock bubble. For those of you who haven't noticed, we are in the midst of a similar market bubble. Most standard valuation measures currently exceed 1929 levels. The 1996 version of "Everybody Ought to be Rich" is the mantra expounded on The Motley Fool; "Every penny you haven't invested in stocks will hurt you in the long run."
And yet, in the long run Mr. Raskob was not far off the mark. Let's imagine that Mr. Raskob's hypothetical young man began investing 15 dollars per month in common stocks on January 1, 1926. He continues doing so until he dies at age 91 on December 31, 1994. Using market return data supplied by Ibbotson Associates, calculations show he would have accumulated $2,462,295. Had he invested in small stocks, he would have $11,730,165. Obviously, this calculation contains a number of unrealistic assumptions: that the principal and dividends were never spent, taxes were not paid, and stocks were bought free of commissions. Perhaps our estimates are off by a factor of 2 or 3; still, the long term results are impressive.
An optimist might cite this as an example of the "magic of compound interest." Too much is made of this phenomenon. A more realisitc observer would note that our industrious saver died an old man without enjoying his fortune -- had he consumed even a few percent of his assets each year his estate would have been vastly smaller. (Over a 69 year period each percentage point of return lost to spending cuts your accumulated total in half. Spend 3% of you assets each year and you have less than $300,000 instead of over $2 milllion.) Me, I'd rather be 25 with a bit of change than old and comfortably well off.
So let's modify Raskob's edict: Everybody cannot be rich, but at least you can leave a lot of money to your grandkids.
William J. Bernstein
copyright (c) 1996, William J. Bernstein