In my previous post, I explored how modern retirement investing (aka buy and hold) works including required rates of return and where they come from. I recommend reading that post before this one.
This post explores one of the key requirements for modern retirement investing to be effective - the future needs to look a lot like the recent past in terms of investment returns.
Supporters of buy and hold point out that, historically, buy and hold worked just fine. They further assume that the future will look a lot like the recent past. While there are obvious concerns with assuming that the future will look like the past (if it doesn’t you might not be able to retire), an exploration of “historical” buy and hold results is eye-opening.
The buy and hold crowd often shares a chart of US stock prices back about 100 years which shows that stocks keep on rising despite a lot of reasons they “shouldn’t” (World Wars, 9/11, COVID, etc.). While these charts are comforting, they omit two key points.
First, the charts typically only focus on the United States which might be an optimistic assumption when viewed versus the rest of the world. To be clear, I’m pro America (‘Murica!) but I’m also pragmatic - especially when it comes to money.
The book Triumph of the Optimists analyzed returns of various asset classes on 16 countries from 1900 to 2000 (101 years) and found that a dollar invested in US stocks in 1900 would have become $710 by the year 2000. Comparatively, a world stock index turned $1 into $295. My point? US stocks did a lot better than average. Quick clarification, these numbers are adjusted for inflation (aka they are “real” vs “nominal”).
The optimist in me likes to believe the United States will continue on as an outperformer and might even do better than the past 100 years. But the pragmatist in me wonders if the United States will remain such a substantial outperformer. If you study history, it is rare for any nation to remain dominant indefinitely.
With that, let’s explore the second major problem.
The 101 year study is robust and convincing. However, it only goes back 101 years. Is 101 years of data enough? I suppose it depends on who you ask.
The following quote comes from Ed Seykota’s website:
Say we compound one penny at a three percent per year interest rate from year Zero-AD to the present. We get about $5.48 * 10^23, or around a half trillion trillion dollars. Clearly someone in those early days has a penny earning interest, per stories of money lenders in temples. That no such investment survives today indicates severe financial setbacks, from time to time, in which people and whole societies experience collapse and have to start over. Compounding interest seems to work pretty well for a few hundred years at a time.
I decided to run my own related analysis. First, I Googled how much money is in the world today and got a lot of numbers but most ranged from about $40 trillion to $90 trillion. To put this in context (and to channel Kurt Vonnegut in Breakfast of Champions which I’ve been reading), 90 trillion looks like this:
$90,000,000,000,000 (4 commas)
Money in the world is a bit tricky because there is cash, credit, etc. so I also looked up total wealth in the world which is said to be around 500 trillion which looks like this:
$500,000,000,000,000 (4 commas)
And now, some math.
If you take $1 at 0 AD (2023 years ago) and compound it forward at 2% for 2023 years you get this number:
$250,119,455,379,742,000 (5 commas)
If you use 3% vs 2% for compounding purposes, you get his number:
$93,262,183,373,376,400,000,000,000 (8 commas)
As stated above, trying to figure how much money is in the world is a tricky endeavor. But regardless of how you go about it, $1 compounding at 3% for 2023 years is a much larger dollar amount than exists in the world today.
What’s the point? The point is modern retirement investment approaches rely on the past 100 or so years and assume nominal (aka not adjusted for inflation) returns on stocks and bonds of around 9%. While this sounds nice, if we compound that $1 at just 3% for 2023 years we get numbers that have no basis in reality. Whatever the reason (Ed Seykota offers some ideas in his quote above), ~9% returns over the very long term did not materialize.
Just for fun, if you compound $1 for 2023 years at 9% you get a number with 25 commas (25 commas!).
As I reread the material above and think about the modern ~9% assumption, I find myself thinking of the Magic Grits scene in My Cousin Vinny. As it relates to modern return expectations in the face of 2023 years of history, I imagine Vinny emphatically saying, “Are you sure about that 9%? Are you sure about that 9%?”
Now you might argue that things have changed, that humans have evolved, that America is unique and earned outsized results because of it. You might also argue that America’s outperformance will continue. With these arguments, you’d undoubtedly find supporters (like the entire buy and hold industry!).
But you’d also find supporters if you argued the other way citing the amount of money in the world (see analysis above), high debt levels in the United States in conjunction with a book like This Time is Different, human nature never changing thus leading to an endless multi-century boom/bust cycle, and more.
Both arguments can be compelling, but the truth is we will have to wait 50 or 100 years to figure out which one proves right.
That said, there are two things we can say with confidence:
Modern retirement investing (aka buy and hold) is making a defacto bet that the next few decades will look a lot like the past 50 or 100 years in America. This is what the models that power the industry rely on - historical returns continuing on as they have in America for the past 50 or 100 years. If you need a refresher on how this works, reread my prior post.
Modern retirement investing has no mechanism to deal with things not going as planned. If returns don’t materialize, modern retirement investing advocates for keeping the faith and waiting it out.
Why does this matter? If markets do behave like the past 50 or 100 years (or better) your retirement should be AOK. If markets don’t behave like the past 50 or 100 years, you might end up Sh!t outta luck come retirement.
If you’re like me, this might make you uncomfortable and you might be wondering what alternatives are available to buy and hold. My response is to sign up for/keep reading this publication or, if the suspense is killing you, reach out to discuss: info@tricapm.com
Unfortunately, the future looking like the past isn’t the only issue. In our next post, we will explore another significant concern with modern retirement investing.
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First thing that came to mind https://en.wikipedia.org/wiki/A_Fishful_of_Dollars