Remembering 12%

By Brad Thomason, CPA

 

The stock market has made its way back into the headlines here lately with its recent highs. It remains to be seen if this is yet another trip to the top of the trading range, or if it will truly break into new territory.  We’ll just have to wait and see.

The stock market of the last 15 years is not the stock market I was told to expect back when I was in college.  Back then it was widely noted that the market’s long term average was an upward move of about 12% a year.  It was posited, that such should be the case out into the future.

Well, it wasn’t.  But what if it had been?  Where would we be today if the 12% assumption had held? Let’s look at some numbers.

It’s going to depend on where you start of course.  If you go back to when I would have been sitting in those finance classes (along about 1993) we had a Dow of about 3700.  By 1996 it had rocketed ahead to 6400.  And to be fair, from the period of 1993 to 1996, that’s a lot more than just 12% a year.  But don’t forget, the question at hand is where would we be today.

If the 1993 Dow of 3700 had grown by 12% a year uninterrupted we’d be at about 32,000 by now.  And if the 1996 Dow of 6400 had grown by 12% we’d be knocking on the door of 40,000.

Those disparities are clear enough that I don’t need to elaborate.  But I will point out a couple of practical implications of these predictions not coming to pass.

Retired folks who made investments prior to 1993 have seen them grow by less than half of what they expected.  Those same investors are also getting a lesser rate of growth on what they now have, which in turn impacts how much portfolio income they can draw off each year without sending the thing into a death spiral.

In other words, less productivity applied to a smaller asset base.

When financial predictions don’t come true the results can be unfortunate.  That is obvious enough.  What is apparently less obvious is that at some point outdated assumptions need to give way to experienced reality.  I say this because there are a lot of people (many at the guidance of their advisors) who are still investing as if it were 1993.

Understand that the implication of sticking to the old view is a vote in favor of the idea that these numbers will someday come to pass (oh, and someday has to arrive before you actually need any of your money).  It means you think that a Dow level in the near-term future of 32K – 40K is reasonable and to be expected.

So the US economy is undervalued by half and the strength of corporate earnings is adequate to drive the market to a >100% gain from where we are right now?

Well, I’ve been around the stock market long enough to know that making definitive statements about where the market is or isn’t going is a perilous activity.  So I’m not going to say it can’t happen.  Because I don’t know.

But I can tell you that I’m not expecting it anytime soon.

You can leave a response, or trackback from your own site.

Leave a Reply