What do you think the Dow Jones Industrial Average will be on December 31, 2099:
- 100,000
- 1 million
- 10 million
- 100 million
"The answer will be in the Berkshire Hathaway annual report...sort of..."
Perhaps the comments below are somewhat akin to the comments Mr. Buffett plans to release at 4:30pm this evening:
On January 18, 1963, Mr. Buffett shared in his letter to partners a discussion on The Joys of Compounding:
I have it from unreliable sources that the cost of the voyage Isabella originally underwrote for Columbus was approximately $30,000. This has been considered at least a moderately successful utilization of venture capital. Without attempting to evaluate the psychic income derived from finding a new hemisphere, it must be pointed out that even had squatter's rights prevailed, the whole deal was not exactly another IBM. Figured very roughly, the $30, 000 invested at 4% compounded annually would have amounted to something like $2,000,000,000 (that's $2 trillion for those of you who are not government statisticians) by 1962 Historical apologists for the Indians of Manhattan may find refuge in similar calculations. Such fanciful geometric progressions illustrate the value of either living a long time, or compounding your money at a decent rate. I have nothing particularly helpful to say on the former point.
The following table indicates the compounded value of $100,000 at 5%, 10% and 15% for 10, 20 and 30 years. It is always startling to see how relatively small differences in rates add up to very significant sums over a period of years. That is why, even though we are shooting for more, we feel that a few percentage points advantage over the Dow is a very worthwhile achievement. It can mean a lot of dollars over a decade or two.
5% / 10% / 15%
10 years: $162,889 / $259,374 / $404,553
20 years: 265,328 / 672,748 / 1,636,640
30 years: 432,191 / 1,744,930 / 6,621,140
Mr. Buffett's letter a year later, dated January 18, 1964, again discussed The Joys of Compounding, with the following example:
Now to the pulse-quickening portion of our essay. Last year, in order to drive home the point on compounding, I took a pot shot at Queen Isabella and her financial advisors. You will remember they were euchre d into such an obviously low-compound situation as the discovery of a new hemisphere.
Since the whole subject of compounding has such a crass ring to it, I will attempt to introduce a little class into this discussion by turning to the art world. Francis I of France paid 4,000 ecus in 1540 for Leonardo de Vinci's Mona Lisa. On the off chance that a few of you have not kept track of the fluctuations of the ecu, 4,000 converted out to about $20,000.
If Francis had kept his feet on the ground and he (and his trustees) had been able to find a 6% after-tax investment, the estate now would be worth something over $1,000,000,000,000,000.00. That's $1 quadrillion or over 3,000 times the present national debt, all from 6% I trust this will end all discussion in our household about any purchase of paintings qualifying as an investment.
However, as I pointed out last year, there are other morals to be drawn here. One is the wisdom of living a long time. The other impressive factor is the swing produced by relatively small changes in the rate of compound.
Below are shown the gains from $100, 000 compounded at various rates:
4% / 8 % / 12% / 16%
10 Years: $ 48,024 / $115,892 / $210,584 / $341,143
20 years: 119,111 / 366,094 / 864,627 / 1,846,060
30 years: 224,337 / 906,260 / 2,895,970 / 8,484,940
And finally, Mr. Buffett explained to his partners:
Our last two excursions into the mythology of financial expertise have revealed that purportedly shrewd investments by Isabella (backing the voyage of Columbus) and Francis I (original purchase of Mona Lisa) bordered on fiscal lunacy. Apologists for these parties have presented an array of sentimental trivia. Through it all, our compounding tables have not been dented by attack.
Nevertheless, one criticism has stung a bit. The charge has been made that this column has acquired a negative tone with only the financial incompetents of history receiving comment. We have been challenged to record on these pages a story of financial perspicacity which will be a bench mark of brilliance down through the ages.
One story stands out. This, of course, is the saga of trading acumen etched into history by the Manhattan Indians when they unloaded their island to that notorious spendthrift, Peter Minuit in 1626. My understanding is that they received $24 net. For this, Minuit received 22.3 square miles which works out to about 621,688,320 square feet. While on the basis of comparable sales, it is difficult to arrive at a precise appraisal, a $20 per square foot estimate seems reasonable giving a current land value for the island of $12,433,766,400 ($12 1/2 billion). To the novice, perhaps this sounds like a decent deal. However, the Indians have only had to achieve a 6 1/2% return (The tribal mutual fund representative would have promised them this) to obtain the last laugh on Minuit. At 6 1 /2%, $24 becomes $42,105,772, 800 ($42 billion) in 338 years, and if they just managed to squeeze out an extra half point to get to 7%, the present value becomes $205 billion.
So much for that.
So, to answer Mr. Buffett's question, re: attempting to predict the Dow Jones Index, circa 2099 - coming off a figure of about 12,000 in the year 2008:
5% compound growth: 1 million
6% compound growth: A little under 2.5 million
7% compound growth: About 5.7 million
And, inverting:
To get to 10 million: Roughly a 7.7% assumed growth.
To get to 100 million: Roughly a 10.5% assumed growth.
- If I had to guess, I'd go with 1 million.
As Seth Klarman said in 2005, markets are inefficient because of human nature:
Interesting to see, of the 1,380 responses so far:
- 31% of responses are for 100,000
- 11% of responses are for 100 million
(Read: 4 out of 10 are emotional)
Shai
