- 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.
- However, even with more modest assumptions significant wealth can be generated over time.
Devil Meets Details
In Part 6 of this series, we explored the hypothetical growth of $1 passively invested in the S&P 500® Index 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.
Again, I call this final row (in red) the Forever Bucket, because 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. Essentially, 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 (Again)
But is a 7.2% real return too optimistic? After all 200 years is a long time. Let’s explore some more modest return estimates and see the impact this can all have on the growth of wealth over time. In Table 2 below we perform the same hypothetical analysis, but this time, instead of a 7.2% real return, we cut our return estimate in half.
This time, instead of our $1 growing to over $1 million after 200 years, it only grows to around $1 thousand over the same period. But before you get too upset by this, let’s put this growth projection into perspective.
First of all, we noted that the long-term average return of the S&P 500 Index was close to 7%, but we also noted that the index on a rolling 45-year basis had a worst-case outcome of something like 3.5%, which is close to our 3.6% estimate that we used in Table 2 above. So we can consider this low return estimate to be a good worst-case scenario (although, if we’re really being honest, the worst-case is the entire market goes down the tubes, but if this happens, it’s likely that we’ll all have far more to worry about than the performance of our investment portfolios).
So with this “worst-case” scenario, $1 turns into $1000, but also $10 thousand turns into $10 million, inflation adjusted. I would surmise that $10 million in anyone’s Forever Bucket would be enough to live comfortably. But perhaps we can look to one of the top 26 wealthiest humans for insight:
Bill and Melinda Gates are giving a reported $10 million for each of their three children: pocket change compared with their $76 billion.—Washington Post
Not a bad existence I must say. But let’s challenge the next assumption: who really has 200 years to wait around? In my next post we’ll dig into this particular concern.