- Assuming a 7.2% annualized real return (including reinvested dividends), an investment will double in value about every 10 years following the rule of 72.
- Given this rate of return, $1 can grow to $1000 after 100 years and $1 million after 200 years.
- After enough gains in capital, incremental income can be consumed on a go-forward basis (practically indefinitely), without eroding the capital base (note: restrictions apply).
Just Another Founding Father
Benjamin Franklin (1706-1790) is best known for his contribution to the formation of our nation, the United States of America. In fact, he is the only Founding Father who signed all four of the major documents that underpinned the country’s formation; namely, the Declaration of Independence (1776), the Franco-American Treaty (which was an alliance with France in 1778), the Treaty of Paris (which effectively ended the American Revolutionary War in 1783), and the United States Constitution (1789).
As a founding father, Franklin had considerable influence on our country’s initial guiding principles. But beyond his political career, Franklin was, “a leading author, printer, political theorist, freemason, postmaster, scientist, inventor, humorist, civic activist, statesman, and diplomat.” (—Wikipedia)
A detailed review of Franklin’s accomplishments would be enough to fill a volumes. Accordingly, it is not surprising to understand that this polymath also had a sound understanding of money and investing. In 1758, Franklin published an essay entitled, The Way to Wealth, which aims to provide its readers with simple and sound advice on how to live within one’s means, and save wisely for the future. It is perhaps for this reason that the $100 bill bestows Franklin’s image to this day. After all, you may even recall his often (mis-)quoted catchphrase:
A penny saved is a penny earned. —Benjamin Franklin (sort of)
Furthermore, Franklin had a profound and solid understanding of the power of compound interest. In his will, “Franklin bequeathed £1,000 (about $4,400 at the time, or about $112,000 in 2011 dollars) each to the cities of Boston and Philadelphia, in trust to gather interest for 200 years.” This initial principal represented the salary he had earned as Governor of Pennsylvania from 1785 to 1788, according to the NY Times.
This man truly understood the power of Investing Forever, for after this holding period, in 1990, the value of these initial funds had grown to millions. By 1990, the Boston trust alone had accumulated to over $5 million, even though the trust had already distributed much of its principal in 1890 (a hundred years prior).
However, it’s important to note that these gains are from interest earned on a savings account. Imagine how much Franklin’s capital would have grown to had he had access to a higher returning investment source, such as a passively managed index fund benchmarked to the S&P 500® Index. We’ll explore this notion in more detail below. The results are almost silly, as you might expect.
In Part 5 of this series, we explored the hypothetical growth of $1 passively invested in the S&P 500® Index over 20 years; now let’s look at the same dollar invested over 200 years. Table 1, below shows the growth of this hypothetical investment using a simple compounding methodology presented in Part 5, where we apply an annualized real (inflation-adjusted) return of 7.2% (before taxes and fees) to our initial investment and allow it to grow unperturbed over two centuries.
I call this final row (in red) the Forever Bucket.
If you manage to get wealth to reach this last row (meaning you’re able to hold on to an investment for two hundred years) something incredible happens given that your money doubles every ten years. At first the growth in principal is small, from $1 to $2 to $4, etc.; but by year 190, you will have over $500k, which doubles to over $1 million by year 200.
From year 200 to year 210 (another ten years), your $1 million will grow to $2 million. At this point, you can spend your $1 million in growth, and just wait another 10 years to spend your next $1 million in growth. And you can basically do this forever.
So an awesome, yet achievable goal for an investor that is willing to think long-term enough to get as much capital as possible into a Forever Bucket, at which point, just as a nuclear fusion reaction becomes self sustaining, so does the your investment. And of course, if you start with $10 in year zero, you will have $10 million after 200 years; and if you start with $1000, you will have $1 billion.
Accordingly, once an investment reaches a Forever Bucket, you can have your cake, and eat it too. There are some caveats to this, which we’ll discuss below and later on in more detail, but the overarching point is that there comes a point where an investment can provide a source of income that can effectively last forever as long as the income distributed is less than the incremental income generated. This is the ultimate goal of Investing Forever.
Back to Reality
Not everyone has 200 years to wait around, but also, not everyone needs $1 billion dollars to make ends meet. So although the Forever Bucket above is targeted at 200 years, your personal Forever Bucket may not take this long to mature. Let’s say you are 20 years old with $10,000 in your pocket, and you plan on retiring at 70: based upon the return assumptions used in the analysis above, you could have close to $320,000 in your Forever Bucket by retirement. This means you can expect an average of about $23,040 (basically 7.2% of $320,000) per year forever.
Above all, this is there true notion behind Investing Forever. First, you need to set aside capital for an investment. Next you need to let the impact of time do its magic (read: math). Finally, once your Forever Bucket has enough capital, it’s primed and ready to go. At this point, you simply need to spend just enough to not erode your substantial principal.
In Part 8 of this series, we’ll challenge some important assumptions that underlie this analysis, beginning with the notion that the 7.2% target annualized real return is variable and possibly an overestimation of what you can actually expect. As such, we’ll investigate this concern and others more detail, and we’ll perform a sensitivity analysis on these assumptions and see if our overarching thesis still holds water.
In this post we explored the notion that wealth can grow exponentially if returns are reinvested rather than spent. Over time, this can lead to a concerning phenomenon, where the “haves” eventually outpace the “have-nots”. This can lead to great imbalances of wealth over time, so it’s worth digging into this particular concern before we proceed with anything else. As such, this will be the main topic of Part 7. The analysis that I will present is shocking, to say the least.