This is Why We Invest in Stocks

I just finished re-reading Burton Malkiel’s investing classic, “A Random Walk Down Wall Street.” As I wrote the other day, Malkiel espouses the virtues of the Index Fund as a vehicle for ordinary investors to “get rich slowly” (Note: nowadays this seems to be a common mantra in personal finance circles, but Malkiel seems to have been an early proponent of it).

Stocks (especially U.S. stocks) are at the center of this beautiful opportunity. Witness the featured image for this post (also taken from the book, p305 of the 2012 edition). On it, the progress of numerous different financial instruments (also the inflation index) over two centuries is highlighted. The specific areas covered are: stocks, bonds, bills (or cash equivalents, or t-bills), gold, and CPI (or consumer price index, which measures inflation).

The graph tells you how each area changed over 200 years. It presumes that you started out with $1 in each area. Here is how you end up:

Area1801 balance2009 balance

In this table, the investment champion is pretty obvious. As Malkiel writes:

“Common stocks have clearly provided very generous long-run rates of return. It has been estimated that if George Washington had put just one dollar aside from his first presidential salary and invested it in common stocks, his heirs would have been millionaires more than ten times over by 2010. Roger Ibbotson estimates that stocks have provided a compounded rate of return of more than 8 percent per year since 1790.”

“A Random Walk Down Wall Street,” p361

According to the chart, $1 invested in stocks in 1801 would have produced nearly $11 million in today’s dollars! This makes every other investment look like, well, pennies in comparison. Granted, to have $1 return nearly $28k (for bonds) is indeed impressive! But it amounts to about 1/4 of 1% (yes, you read that right) the return of stocks.

To be fair, this is a hypothetical growth for a hypothetical investment that actually couldn’t exist, at least not for the companies in the U.S. stock market. I don’t know exactly how these numbers were arrived at*; presumably it reflects the long-term value of $1 invested in the market as a whole (if there had even been an option back then, which there wasn’t to my knowledge). Also, most of us aren’t thinking about the next two-hundred years in our portfolios (although why shouldn’t we? This guy does).

Nonetheless, the point is made: your best long-term bet for compounded growth may be stocks.

A note about the CPI. As far as I know, the $17.85 amount quoted under 2009 means that by then, what would have cost $1 in 1801 cost nearly $18 by 2009. This is consistent with the pattern of inflation of the dollar. Although such inflation can sometimes appear large (They’re charging WHAT now for that?), it pales in comparison to the returns of any of these financial instruments when considered as long-long-long-term investments. In other words, each of the financial instruments outpaced inflation over the two-hundred year period in the chart.

Side note: seeing things like this chart is exactly what gets me excited about the power and magic of compounding šŸ™‚

*For those who are curious, Malkiel attributes the graph to Jeremy Siegel in his book Stocks for the Long Run. I may have to read that!

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