The Dow Jones Industrial Average in 2060 will be trading at 767,702 -- if its gains over the next 40 years are as good as they were over the past 40.
The occasion for this fantasy is the Hulbert Financial Digest’s completion of a full 40 years of tracking the performance of investment newsletters. The Dow stood at 867.92 on June 30, 1980, when the HFD first constructed model portfolios to track those newsletters returns.
This walk down memory lane leads immediately to the first investment lesson I want to draw from my 40 years of performance tracking: The power of compounding.
Though 767,702 seems inconceivable to us now, just remember that today’s Dow levels would have seemed equally so in 1980. And yet, to produce this inconceivable 40-year return, the Dow “only” had to advance at the annualized rate of 8.9% on a price-only basis.
Another way of making this same point is to consider the investment newsletter that made the most money over the past 40 years. I’m referring to The Prudent Speculator, edited by John Buckingham. Its annualized dividend-adjusted return was 14.1%, or nearly three annualized percentage points ahead of the Dow’s dividend-adjusted return.
When I communicate these returns to clients, some of them express disappointment. You mean that the very best newsletter only beat the market by three annualized percentage points? You mean that its overall annualized return was less than 15% annualized?
But consider where the Dow will be in 40 years if it compounds at a rate that is three percentage points better than it did over the past 40 years. In that case the Dow in 2060 will trade for more than 2.2 million.
That should be more than enough to produce riches beyond the dreams of avarice, to quote the great Samuel Johnson.
The reason to point this out is not just to discourage you from being greedy. It’s also to encourage you to develop realistic expectations. If you set your sights on returns well in excess of The Prudent Speculator’s, you not only will be disappointed but you will be tempted to make increasingly aggressive and desperate bets in hopes of producing your expected returns.
To help you from getting discouraged, let me offer you a few other relevant facts.
First, consider that the best-performing equity mutual fund over this same period did only marginally better than The Prudent Speculator. This fund, as best my analysis can determine, is the Alger Spectra Fund (SPECX) - Get Report; it produced a 15.6% annualized return.
Second, consider Warren Buffett’s return. Buffett, of course, is the CEO of Berkshire Hathaway (BRK.A) - Get Report (BRK.B) - Get Report and widely considered to be the most successful investor alive today. The net asset value of Buffett’s company has grown at an annualized rate of 17.8% over the past 40 years.
These factoids should throw cold water on your inflated expectations. If the absolute best investment advisers -- whether in the newsletter arena, mutual fund industry, or in Warren Buffett’s league -- do not produce annualized long-term returns in excess of the mid-teens, what do you think the chances are that you will be able to do so?
But notice that, even with reduced expectations, you should be able to make more than you previously dared dream possible. By holding on long enough, less can turn out to be way more.
Full disclosure: The Prudent Speculator is one of the newsletters that pays a flat fee to have its returns audited by my performance-tracking firm. Because all newsletters pay the same flat fee, there is no incentive to make any of the firms come out on top.