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The 10% Return on Equities Myth

According to historical records, the post-war return of the stock market has been around 12%. It’s a number that has used over and over again (more often people use the 10% value) as the benchmark for stock returns and project of future results, since it’s better than pulling a number out of thing air. However, yesterday afternoon I had the pleasure of reading Warren Buffet’s 2007 Letter to Shareholders of Berkshire Hathaway [3] (if you’ve never read one, you should because it is both informative and entertaining, 2008’s is a mere 21 pages long and chocked full of fun facts).

On Page 18, right after Buffett chastizes 498 of the Fortune 500 for not recording stock options as expenses on their books, he starts talking about the Dow returning 5.3%, compounded annually, in the 20th Century. Wow, what happened to this 10% business? Why are we using it as a benchmark if the Dow’s return over the last hundred years (arguable, the last hundred years starting 8 years ago) is a meager 5.3%? I don’t know, but even assuming 5.3% is pushing it.

Buffett goes on to illustrate that a 5.3% annualized gain going forward would mean the Dow would have to pierce 2,000,000 (that’s two million!) by the end of 2099. That’s working with only 5.3%. If you want 10% annually then you’ll need the Dow to hit 24,000,000 by 2100. Twenty four million…

Though, nominal numbers are merely that, nominal. If you asked someone at the start of the 20th Century if the Dow was going to grow from 66 to 11,497 (especially after you told them the horrors that would come during the Great Depression), they probably would’ve laughed too. So, will Warren Buffett’s prediction that a 10% is outlandish and unreasonable hold true?

I don’t know but I’ll tell you what… while historical returns are not indicative of future results, Warren Buffett’s historical returns are better than my historical returns so I’m siding with him on this one.