In the halcyon summer of 1929 John J. Raskob, a senior
financier at General Motors, granted an interview to Ladies Home Journal.
The roaring twenties' financial zeitgeist is engagingly reflected in this quote
from the article, entitled modestly, Everybody Ought to be Rich:
Suppose a man marries at the age of
twenty-three and begins a regular savings of fifteen dollars a month -- and
almost anyone who is employed can do that if he tries. If he invests in good
common stocks and allows the dividends and rights to accumulate, he will at the
end of twenty years have at least eighty thousand dollars and an income from
investments of around four hundred dollars a month. He will be rich. And
because anyone can do that I am firm in my belief than anyone not only can be
rich but ought to be rich.
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.
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