By Allyn Hughes, CFP®, CLU®, ChFC®, CAP®
Chuck Jaffee is a senior columnist at MarketWatch whose work is syndicated in many newspapers. Recently, he wrote about the levels that the Dow Jones Industrial Average (Dow) or the S&P 500 indexes would attain if they match the rates of growth that the U.S. stock market has achieved over the past 50 years.
Jaffee used the “Rule of 72” which we have discussed before, to keep the math simple. This rule says if you can achieve a 7.2% average annual return on an investment, that investment will double in value every 10 years.
Jaffee used this rule to project levels of the Dow at different dates in the future. For instance, he suggested that because the Dow is now at around 18,750 then in a decade (July/August 2026) the Dow could be at around 37,500. In 20 years, July/August 2036, this value should double to approximately 75,000. Finally, by July/August 2046 this index could be around the 150,000 level.
I read this and tried to determine if this was good information to present to readers. His point was generally good one — “just keep investing in spite of the crisis du jour because that is how you will achieve good returns.” I also thought I’d do a little more research on this matter. If you are an investor who believes in recency bias – the tendency to weigh recent information as more important than older data – then you might come to different conclusions about the trend of U.S. stocks. For instance, according to the web site 5yearcharts.com, the “index value (of the Dow) has grown from 11,144 to 17,481 throughout the past 10 years (ending April 2, 2016) which equals only 4.61% annual profit (return).”
The average annual return for the past 10-year period for the S&P was slightly higher at 4.71%. So, if the returns of the past 10 years continued for the Dow, then in 2026 the Dow might be at 29,400 or so, and not the 37,500 level expected. Continue this trend for another decade and the Dow is at 46,180. Because this underperformance has occurred for a longer period of time, this underperformance is now 28,820 points! (75,000 – 46,180).
The math of compounding returns can add up impressively or very slowly with just a few percentage points difference in performance. This is why your financial plan needs a margin of safety to accommodate for the possibility that markets may not be in your favor, even over long periods.