Original Link | InvestmentU by Alexander Green, Chief Investment Strategist, The Oxford Club
When it comes to the long-term future of the United States, Oxfordians are an optimistic bunch.
We recognize that we have the best businesses, universities and hospitals on the planet.
We lead the world in energy production, science, technology, entertainment and the arts.
No nation attracts more immigrants, more students or more investment capital.
Our country is the most affluent and charitable in the world.
And we have by far the widest, deepest and most transparent capital markets.
Yet when Warren Buffett predicted at a New York event this week that the Dow would hit 1 million in 100 years, a colleague scoffed.
“That’s crazy talk,” he said.
“It really isn’t,” I countered. “In fact, it may be conservative.”
He looked at me like I’d forgotten to take my meds. So I tapped on my phone’s calculator.
A million sounds like a lot when the Dow is trading closer to 22,000. But a century is a l-o-n-g time for money to compound.
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Plug in the numbers and you’ll see that the Dow would only have to rise 3.87% a year to reach 1 million in 100 years’ time.
However, this example doesn’t include dividends.
Tack on the current 2.1% yield and the average annual total return would still be just under 5%, or roughly half the Dow’s long-term average return.
Yet this example is still too conservative because it assumes static dividends. They will rise with earnings over time.
When you divide the current level of the Dow by those future dividends – which we cannot know with any certainty now – the yield will be considerably greater.
And so will the total return. So Buffett’s estimate is somewhere in the right ballpark. (The Dow actually rose 5.7% annually over the last 100 years.) More to the point, I like his perspective.
He pointed out at Tuesday’s event that when you look at the Forbes list of the 400 richest Americans, you don’t see the names of any short sellers.
“It has been 241 years since Thomas Jefferson wrote the Declaration of Independence,” he said. “Being short America has been a loser’s game. I predict to you it will continue to be a loser’s game.”
I couldn’t agree more. Yet I’d add this note of caution…
Just because a portfolio of common stocks – whether measured by the Dow, the S&P 500 or the Wilshire 5000 – has averaged 10% a year for more than 200 years, that doesn’t make it a certainty going forward, even when measured in decades.
Risks to our economy and national security remain. The world’s nuclear club is getting bigger, for example. And our nation’s debt and unfunded entitlement liabilities, as a percentage of GDP, have never been larger.
Historic returns are not hard constants like the speed of light or the force of gravitation. And investors drawing conclusions based on those returns may be disappointed, especially in the short term.
To a great extent, the future is always hidden. Uncertainty will always be our inseparable companion.
So while it’s smart to be optimistic, it also pays to hedge your bets.
And to remember that wherever the Dow may be 100 years hence, it’s not likely that you or I will be around to enjoy it.
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