the double digit myth

Quoting directly from an annual report is not something I’ve done before on Brip Blap, but I thought this little nugget from Berkshire Hathaway’s CEO Warren Buffett was worth sharing. Friday’s annual report to shareholders is available on Berkshire Hathaway’s website.

From Fortune:

[Buffet] writes that the Dow Jones Industrial Average surged from 66 to 11,497 during the 20th century. That is a huge rise – yet it averages out to just 5.3% compounded annually, Buffett writes. What’s more, were the DJIA to repeat that 5.3% average annual gain throughout the 21st century, its value on Dec. 31, 2099, would approach 2 million.”It’s amusing that commentators regularly hyperventilate at the prospect of the Dow crossing an even number of thousands,” he writes. “If they keep reacting that way, a 5.3% annual gain for the century will mean they experience at least 1,986 seizures during the next 92 years. While anything is possible, does anyone really believe this is the most likely outcome?”

If that scenario isn’t outlandish enough, Buffett goes on to note that were stocks to return 10% annually throughout this century, the Dow would hit 24 million by year 2100. “If your adviser talks to you about double-digit returns from equities,” he writes, “explain this math to him – not that it will faze him. … Beware the glib helper who fills your head with fantasies while he fills his pockets with fees.”

I’ve written about this before. I am constantly amazed at the fervor people bring to the concept of long-term guaranteed double digit returns in the stock market if you invest in index funds. I am even more amazed that people hope for the US market to continue at these rates of growth, since I think the explosive days of US growth are behind us, as a country. The simple truth is that unless you are a very good investor (and they exist – I don’t deny that) you probably can’t beat the market. 75% of mutual fund managers can’t, either. What is most likely is that you can count on a before-tax return of less than 6% per year – before taxes.

I know the DJIA is probably not the best single measure of returns, and I know different time spans would result in different return rates, and I know there are variables such as tax treatment, dividends, etc. that might affect this calculation. But the best investor in America (if not the world) thinks that counting on the general return of the market to exceed 5.3% is foolish, and I have to pay attention to his opinion since he seems to have a good understanding of investing, to say the least.

I use the “index fund method” of investing, buying broad-based index funds that mirror the performance of the market. If I look back in 20 years and see 5.3% returns per year I will kick myself for not buying CDs instead and avoiding the volatility which is giving me nightmares today. I sometimes wonder if I do need to put more effort into actively picking stocks, instead of hoping for the lift and swell of a troubled, debt-ridden country’s over-regulated stock market to carry me to retirement. It’s enough to make you sleepless at night in times like these.

22 Replies to “the double digit myth”

  1. I own a few index funds, a few ETFs and 2 single stocks, one of which is BH. I don’t really expect to make a 20 percent return yearly until I am 60 but I hope to beat 5.3. Maybe I’m delusional. Time will tell. I always like what buffet has to say.

  2. William Bernstein, among others, has written about these sort of returns going forward too, and I have no reason to doubt ’em. I’ve often wished all these bloggers I visit happily assuming avg 10% in their varied scenarios would explain why they think so many experts are wrong on this front.

  3. I just figure I’ll be happy with the market, since I don’t expect to beat it. And if I’m not thrilled with the results, I’m the type to console myself it wasn’t worse rather than take more risks in an uncertain situation.

  4. While even the great Warren Buffet recommends that the neophyte investor puts their money into broad-based, low-cost index funds …

    … if you are a student of investing, have a long-term view and are willing to dedicate some time and effort, take note that Warren offers exactly the opposite advice for you …

    “Wide diversification is only required when investors do not understand what they are doing.” Warren Buffett

    I also bet that if you compound Warren’s 40 year returns, you will get FAR MORE than 5.3% compunded!

    So, now you have two “Warren Buffet Approved” strategies to choose from!

  5. The more I think about it, the more I realize how tough it is for the average investor to earn more than a bank CD nowadays. I try to use 8% ROI in any of my index fund calculations now, which may even be high. I’ve contemplated some real estate deals lately that would translate into an estimated 10-12% annual ROI before tax..but nothing explosive as well. I think the time of easy explosive growth is behind us..

  6. I’m not sure the “outlandish” numbers are such a great argument (wouldn’t investors in 1902 have thought 11,000 was insane?), but I agree that none of us (even excellent investors) should count on double-digit returns. I usually do my long-term calculations based on 3%, 5%, and 7% interest, and it sounds like even that may be expecting a lot according to Buffet.

  7. @7million7years: Actually I think in the article it mentions that Buffet’s returns are about 21% annually over his “career.” Not too bad – that’s doubling your money every 3 years or something like that on a compounded basis.

    @Elizabeth: No, you’re right – 11,000 probably sounded like crazy talk in 1902. 1,000,000 in 50 years? Maybe. If I knew I’d be a talking head on CNBC, so who knows…

    @emily, Mrs. Micah, Guinness416, Danny,Elizabeth: Buffet seems to indicate (and 7million7years points this out) that for most of us non-professional investors, if we hang in with the market that’s better than trying to beat it (and failing). It’s just a little depressing, but it’s the best you can do unless you want to become a full-time market analysis.

  8. How do we reconcile the 5.3% figure with this:

    “Since 1928, according to the University of Chicago Center for Research in Securities Prices (CRISP), small stocks have provided an annual return of 12.5%, vs. 10.8% for large caps.”

    ( – dated 6/26/2002 so it caught some of the dot bomb)

    With a big crash right around the corner, 1928 should be an unfavorable year for starting any measurement of stock performance, right? So why is the 10.8% figure for large caps so much higher than the 5.3% for the Dow? Some wild guesses:

    1. Stocks tanked from 1900-1927.

    2. What they’re calling “large caps” is a very different basket of stocks from the Dow.

    3. The Dow was not measured consistently for the entire 20th century (like hypothetically, if one day someone decided the Dow should be 30 stocks instead of 100, so it instantly plummeted).

  9. @Hunter: Fairly simple, really – your first two points make the case. Buffet’s looking at 1900-2000 (the 20th century). My guess, without researching it, is that stocks were fairly flat from 1900-1927 (not tanked, but probably minimal growth) because until the early 80s most stocks were in the single digits and had been for the previous 80 years. And second, “large caps” is a much larger universe than the Dow. The Dow changes, of course – stocks are added and removed from time to time – but to the best of my knowledge there was never a massive change of a 100 – 70 = 30 nature.

    Individual stocks, or small stocks, or stocks that begin with the letter U might have done much better, of course. The trouble is that the individual investor, hoping to identify the “best” sector, is unlikely to beat the market – since most professional money managers can’t, either.

    Statistics, of course, are arbitrary. Vanguard has some interest in convincing people to buy index funds, of course. Buffet has some interest in convincing people he is smarter than an index fund investor, of course. I simply think Buffet’s point is interesting because it challenges a dearly – almost religiously – held belief in the stock market as an automatic wealth creator and for many people it will not be true. As more and more people enter the market through 401(k)s, etc., it’s going to become a more critical question for the US.

  10. The fact is that nobody – even Buffet, knows what the market is going to do over the next several decades. As you know, I am all about ETFs and asset allocation and will live with whatever the investment return gods decide is right for me.. 🙂


  11. I saw that analysis by Buffett as well and had the same reaction you describe: I might as well invest in CDs then.

    Of course, I might just invest more in Berkshire. The very tiny portion of a Berkshire B share that I own is up over 15% in the last three months. 😀

    1. @CFO: Well, yes, investing in Berkshire would be the logical thing if I really truly believed he was right. The evil little gremlin in my head still thinks I can beat everyone with my investing brains (an expectation not borne out by past results). But you’re right – following the smart dudes is always a good plan (although Buffet, by his own admission, is not infallible).

  12. I have been struggling with this for several years. I am inclined to “own” companies and not invest in index funds. However I appreciate that ensuring you keep up with the market is at times better than beating the market every once and awhile. Someday I hope to be an investor like Buffett — until then I need a heavier concentration in index funds.

  13. Add to the 5.3%

    Average Dividend Yield (%) of
    All Dow Jones Industrial Average Stocks 3.13

    This is not included in the figures.
    With dividend reinvestment, not looking at 15% tax on dividends its not that bleak.

  14. drelfei,

    It does look like Buffet does not account for dividends in his forecasts of the 5.3 % return. I read a research paper, where they calculated the value of Dow Jones Industrials Average with dividends being reinvested. They found out that if you started in 1928 and reinvested all dividends untill 2000, the value of the Dow would have been around 250,000 by 1999 yearend. Pretty nice, compared to the 11,750 high that Dow hit in 2000…

    Also, do not believe everything that Buffet tells you. Buffet is a market timer. HE does sell stocks occasioanly. He does trade in futures ( currencies). He does use derivatives in his insurance businesses ( he also sold some long-term put options contracts (20 years or more) )
    If you read his early partnership letters from the 1950’s and 1960’s , you will see that he always forecasted below average stock index returns.
    But he also mentions that he is not in the business of forecasting ( lucky for him) but in the business of buying good solid companies.

  15. Maybe a little off subject but not far off…in an economics class I’m taking they talked about the GDP growth rate for the US from 1870-2000. The average GDP growth rate in that period was about 2% per year. 2% growth for the largest economy. 2% made our economy pretty large.

  16. You’re just peeved because you can’t invest in BRK-A or -B because they don’t pay dividends 🙂 Warren takes the (perhaps rather) presumptive view the he can invest the dividends better than we can. AJC.

  17. This is exactly why I have no money in index funds. They are a trap. If everyone does something, it can’t be that great, because everyone can’t be rich.

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