A Historical Perspective
I was recently asked to comment on the best investment advice I had ever received. Without hesitation, I told the story of an experience that began on a jetway as I was waiting to board a flight from Pittsburgh to Chicago and ended as I shook hands with the well-dressed and exceptionally educated man who shared his wisdom with me.
I was a young CPA attending a conference in St. Charles, Illinois, just outside Chicago. It was October 18, 1987. The gentleman and I struck up a conversation while boarding our USAir flight. As fate would have it, we were seated in the same row; he had the window, I had the aisle, the middle seat was empty. He was a seasoned, 56-year-old investment banker returning home from a Pittsburgh closing. I was a young professional with a two-year-old daughter and a son on the way. After learning that I was headed to St. Charles to attend a conference designed for CPAs delivering investment advice, he began to share his wisdom.
He asked: “Do you understand how wealth is created?” Anxious to hear his explanation, I simply looked at him with a puzzled look. He began by sharing the history of Cornelius Vanderbilt, an American business magnate who built his wealth in railroads and shipping. He then told me the story of Andrew Carnegie. While Carnegie started work as a telegrapher, by the 1860s he had investments in railroads, railroad sleeping cars, bridges, and oil derricks. He accumulated further wealth as a bond salesman, raising money for American enterprise in Europe. He built Pittsburgh’s Carnegie Steel Company, which he sold to J. P. Morgan in 1901 for $303,450,000. It became the U.S. Steel Corporation. After Andrew Carnegie, he told me the story of Sam Walton. Sam went from being a management trainee at JC Penny to creating the largest retailer in the world, Wal-Mart.
He then asked me this question: What did these men have in common?
The three examples he used made it easy to respond. These men were Americans who understood that owning a business that meets the needs of the people is a path to prosperity and fortune. These men understood that risk-taking was not defined in the way most investors understand risk. For these men, the risk laid in failing to invest in their businesses. They understood that successful businesses require focused attention and reinvestment to continuously improve and stay in front of competitors. And that is precisely what they did.
Each of the men he cited had become the wealthiest person in America at one point. They were driven to succeed. The businesses they started and managed reflected their American entrepreneurial spirit and their success created vast wealth.
His point: Wealth is created by business owners! A simple concept that all are able to embrace.
He then went on to give me several examples using the Dow Jones Industrial Average. In 1987, the DOW included Westinghouse Electric, F.W. Woolworth, Bethlehem Steel, and US Steel. Today, the DOW includes Apple, Microsoft, Home Depot, and Walmart. Since 1987, 28 DOW companies have been replaced
Here his point was also simple: Own the best American companies and you too will create wealth.
Obviously, he was unaware of the companies that would come and go from the DOW. The same could be said of the S&P500, the NASDAQ 100, the Russell 1000, or any other index we might choose to examine.
From January of 1987 through June of 2020, the Dow Jones Industrial Average returned 2879% if dividends were reinvested, 10.69% annualized. Adjusting for inflation, the return was 7.96%.
The S&P500 Index total return after inflation was 7.3%.
Had the same investment been made into 10-year U.S. Treasury bonds with coupon reinvestment, the return was 462% or 5.3% annualized. After inflation, the Treasury investor earned 2.7%. The business owner earned nearly three times the amount that the Treasury owner received! So, as Vanderbilt, Carnegie and Walton understood, the risk was, and is, in NOT investing.
Earlier I commented that my plane ride occurred on October 18, 1987. One day later, on October 19, 1987, the DOW experienced its largest single day percentage drop on record. That day came to be known as Black Monday—the day the DOW dropped 22.6% in a single day. Black Monday remains the single worst day in the history of the DOW. Since that day, the DOW has registered 9 of its 20 largest point declines in history. Despite those declines, the index still returned an annualized rate of 10.69%. To earn the return an investor had to get in—and then, stay in—the market. An investor had to trust that the greatest economy in the world could and would recover from any calamity. It always has, and we remain quite confident that it always will!
The 10.69% annualized return occurred over 33.5 years. Clearly, 33.5 years is “long term.” During that same period of time, there were lengthy periods of negative returns. From October 1987 through May 1988, the annualized return was -14.14%. From March of 2000 through March of 2009, the annualized return was -1.85%. From October of 2007 through December of 2011, the annualized return was -0.53%. We offer these examples only to point out that time matters. An investor in for the 33.5-year ride experienced the nine-year period of negative returns ending in 2009. That same investor experienced each of the declines noted above and many more, yet earned an annualized 10.69%.
Imagine the case where an investor began investing in March 2000 and stayed in through today. That investor earned 7.14%, substantially less than the 10.69% previously cited. Despite the decrease in returns, the investor still out-earned the 10-year Treasury return of 4.24%. After inflation, the DOW investor earned 5.02%, while the Treasury investor earned 2.18%. In this instance, the DOW returned 2.3 times the after-inflation return of 10-year Treasuries.
So why are we sharing this data with you? We recognize the critical components in developing an investment plan are these:
- Fully documenting and understanding the investor’s goals;
- Fully documenting and understanding the investor’s capacity and willingness to accept risk;
- Building the plan to meet current income needs with less volatile, income-producing securities;
- Building the plan to meet capital appreciation goals with stocks that can and should be owned for a long period of time; and
- Regularly reviewing the goals and the securities owned to keep the portfolio aligned with the goals of the investor.
To be clear, money needed over the next three to five years should not be in the stock market. Conversely, money needed in 15 years should be invested in stocks and allowed to grow.
Over the past four months we have offered this weekly update as a means of informing and educating our readers. We have been careful to caution our readers about the current behavior of the markets and have been equally careful in pointing out the disconnect that exists between Wall Street and Main Street. Many Americans remain unemployed. Many businesses are shuttering their establishments. Covid-19 remains an ongoing threat to our health and welfare. Yet, we march on. We go to work. We care for our families. We do what is necessary to meet the needs of those we love and care for. Business owners are doing everything they believe is necessary to remain viable in the Covid era. Some are making difficult decisions in hopes of survival. Others are prospering from the rapid change in consumer behavior. In every period of despair, one can find hope and opportunity. At PWA, we remain steadfast in our belief that this era will end and be followed by a period of expansion. Understanding our history allows for no other conclusion.
Thank you for your continued confidence.
Joseph A. Scarpo
Founder & CEO