The Dow Jones Industrial Average from 1971 - 2009
There is a famous joke that Woody Allen tells at the end of Annie Hall, which seems so pertinent with regard to investing:
A guy tells his buddy, “My brother thinks he’s a chicken.”
And the buddy responds, “ You should have him committed to an asylum.”
The guy retorts, “Well we would, but we need the eggs…”
I love the fact that the guy makes no qualms about his brother’s sanity. He knows his brother is nuts but believes that staying insane is in the family’s best interest. They need the eggs…just like so many of us now need returns on our investments.
In order to retire, most Americans need their savings to grow. Growth rate assumptions vary but the common understanding is that equities return 8% per year on average. Eight percent! This is the assumption that the brokers use when they calculate the “future expected value.”
How much money do we need for Junior’s college? The broker or advisor enters in some factors, and Voila! the computer spits out an entire analysis, retirement assets, income expected et al. The analysis is based on the assumption that your stocks will all go up 8%.
Seems crazy.
The 8% growth was a real number. 8% was the average return on equity over the past 100 years. However the last 100 years were not “typical,” and assuming that the type of growth and innovation we experienced on planet earth over the past century will continue on unabated at the same or even higher pace is overly optimistic.
The world became industrialized over the past 100 years. We had a revolution in science and technology that changed earth from an agrarian planet to an industrial planet. Tools and machines that made people infinitely more productive helped to drive the standard of living higher and higher. Profits were unleashed in all areas of our existence. Everything changed in dramatic fashion. Electricity, air-conditioning, rockets, planes, penicillin, computers; the amount of change in the 20th century was unprecedented.
In order to produce all of these goods, huge amounts of credit were needed. Someone had to put up the money. The financiers and investors were rewarded handsomely. Their investments paid big returns. They took risks, backed entrepreneurs and visionaries. Built rail roads and roads and cities.
However, things are different now. We’ve built all of the roads. We’ve strung the wire and installed the plumbing. We’re computerized, and digitized. The corporations are faced with more and more competition as 2nd and 3rd rats join the race.
The returns on equity are not the same for maintaining a new society as they would be for creating a new society. It stands to reason that the returns we saw over the past 100 years were high because the development was so incredible. It also stands to reason, that unless we remake our society in an equally dramatic and amazing way, our returns on our assets would be lower going forward.
Millions upon millions of people rely on the 8% assumption. The 8% assumption is embedded in their retirement calculations, in their college savings plans, and in their insurance company future benefits. People should make sure that they are not basing their retirement on 8%. If I am wrong, we can all throw a big omelette party.
Just trying to help.
J.O.Y. to the world,
peter
Tags:
college savings,
credit,
industrialization,
investing,
retirement,
Second Rat Gets the Cheese,
stock market,
technology,
Woody Allen 
