Clem Sunter

The beauty of round numbers

2009-07-23 07:44

You are 10 years old, living in New York in 1916.  Your father establishes a trust for you and puts in a variety of blue chip shares worth $10 000. He then whisks you off to the Amazon jungle because he is a keen botanist.  You are essentially cut off from the world because you develop an interest in botany too while you work alongside him.  All the dividends on the shares in the trust are remitted to you as living expenses.

Twenty six years later in 1942, you make your first return visit to New York and check up on the value of your trust. The lawyer who looks after it says that it is still worth $10 000, having risen to just over $30 000 in 1929 and fallen to $4 100 in 1936. You are relieved you missed the drama and are reassured that your trust still has its capital intact.  Back you go to the isolation of the jungle.

In 1966, after another twenty four years you decide to celebrate your 60th Birthday in New York and ascertain the latest value of the trust. To your delight it has multiplied nearly ten times to close on $100 000. That makes you very happy as you trek back to the jungle for your final stint. You reflect on how different the result was for 1942 to 1966 compared to 1916 to 1942, despite the fact that the intervening periods were similar in numbers of years (24 versus 26).

Finally, you retire hale and hearty and come back to New York in 1982 sixteen years later.  You pay a visit to the same legal firm expecting another substantial increase in the value of your trust. This time the lawyer has a resigned expression as he tells you that your trust has not appreciated at all. It is still worth about $100 000.

So in light of the fact that you have been a fairly successful botanist, having discovered a couple of brand new plant species and made a fortune out of one of them as a medicinal herb, you decide to leave the capital in the trust. At the ripe old age of 93, after seventeen years of luxurious retirement in Long Island, you think it is time to take one last look at your father’s trust. Lo and behold, its assets amount to $1 000 000 making you, as the sole beneficiary, a millionaire at the end of the millennium (or worth $66 000 in 1916 terms).

Even though your father has been dead for a long time, you want to give him a hug for reaching this important milestone. Once more, you can’t help noticing that the two periods, 1966 to 1982 and 1982 to 1999, were similar in length (16 versus 17 years).

The morals of the story

So what are the points you should take away as an investor?

1. I specifically chose these years on the grounds that they mirror the behaviour of the Dow Jones Industrial Average – the blue chip benchmark of Wall Street. At some time in 1916 it was 100, in 1942 100, in 1966 just shy of 1 000, in 1982 1 000 and in 1999 10 000. That is the beauty of round numbers: you remember them.

2. These figures show that capital appreciation on the stock exchange goes in waves. When some financial adviser smoothly says to you that if you hold shares for long enough, you are bound to win over other investment options the answer is: it all depends on when he says it. The long run can be very long if you get the timing wrong.

3. Right now we are ten years into a period of no capital gain similar to 1916-1942 and 1966-1982. The DJIA after zigging and zagging is still below the 10 000 level established in 1999. Obviously, you could have made money if you were a shrewd trader like Goldman Sachs, but for normal mortals it is a risky business.

4. The good news is that the DJIA at some stage will begin a long-term ascent towards 100 000, ten times the current baseline of 10 000. The bad news is that the beginning of the ascent (when it crosses 10 000 on the way up for the last time) may take place at a much later date than the market gurus are currently suggesting.

5. A hundred times your money in 83 years sounds a lot, but expressed in compound growth rates the result appears quite modest. For the record, between 1916 and 1999 the botanist’s annual capital growth on his portfolio was 5.7% in nominal terms and 2.3% in real terms (after allowing for inflation of 3.3%). Based on historical charts, his annual dividend yield would have averaged around 4%. Nearly two-thirds of his overall monetary gain from the trust was therefore attributable to the dividends that he consumed over the years on living expenses.

This shows just how important yield is in the scheme of things.

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