098: Versus “The Gathering Darkness” Part 7 – Outcome of a Lifetime Commitment to Equities

0:00:00 – Jonathan DeYoe
We’ve discussed how words matter in investing, specifically noting the psychological implication of calling the thing we own equities or stocks instead of great companies and great businesses. We’ve outlined the importance for investors of having an adult memory. We’ve stated my favorite characteristics of rational profit-seeking businesses, which is their absolute refusal to lose money for any longer than necessary, and my second favorite unique characteristic, their embrace of innovation. I described why all retirement income investors should love owning shares of the great companies at the US and the world for that benefit growth of income.

0:00:41 – Jonathan DeYoe
Do you think money takes up more life space than it should? On this show, we discuss with and share stories from artists, authors, entrepreneurs and advisors about how they mindfully minimize the time and energy spent thinking about money. Join your host, jonathan Diyo, and learn how to put money in its place and get more out of life.

0:01:06 – Jonathan DeYoe
Hey, welcome back to Mindful Money. Today we’re going to get into part seven of our Versus the Gathering Darkness program, which I consider our step-by-step case for owning publicly traded shares in the great companies of the US and the world. If you’re just tuning in, over the last seven weeks we have suggested that wealth is created by owning businesses and that the reason most people don’t own, or don’t own enough of these great businesses can be summarized as the Gathering Darkness. We’ve discussed how words matter in investing, specifically noting the psychological implication of calling the thing we own equities or stocks instead of great companies and great businesses. We’ve outlined the importance for investors of having an adult memory. We’ve stated my favorite characteristics of rational, profit-seeking businesses, which is their absolute refusal to lose money for any longer than necessary, and my second favorite unique characteristic, their embrace of innovation. I described why all retirement income investors should love owning shares of the great companies of the US and the world for that benefit growth of income and we’ve revealed the summary objection to owning equities this time is different which, once understood as such, allows one to dismiss it without digging into the details and know with confidence that this too shall pass.

This is the seventh of nine episodes of the Mindful Money versus the Gathering Darkness series. It brings a close to the entire exposition of why I own broadly diversified shares of the great companies of the US and the world. The only thing left after this is to define the equities I’m talking about when I say great companies of the US and the world, and there’s a lot here today. So buckle up. Fair warning this is a longer piece. Last week I spent the day identifying the genus objection to my devotion to owning shares of the great companies of the US and the world. I called it the summary objection. We learn to beware the phrase. This time is different because, even if the details of the catastrophe differ, the five core reasons we prefer ownership in the great companies of the US and the world over other investments do not change Ever.

The catastrophe, while immediate and scary, has always been short term. The inconceivable value created by business, while slow and imperceptible, has always been long term. There will always be zigs and zags in markets. We experience the low causing catastrophe, which are always short term, and the high causing values, which are always long term, as volatility that moves our account values up and to the right through a series of higher highs and higher lows. The declines are temporary, the advance is permanent.

The goal, as Charlie Munger so wisely expressed, is to never interrupt compounding unnecessarily. This week we play this idea through. We tease out the implications of maintaining such a devotion to owning great publicly traded businesses and not interrupting compounding for a lifetime, from the very first dollar saved, from the first job, through the retirement income we can’t outlive, to the legacy we leave behind. Today we’ll play the tape all the way through, from beginning to end, expounding on one of Warren Buffett’s less famous quotes my life has been the product of compound interest. By doing so, I hope to express the very real and very possible benefits of a financial life committed to compounding the inconceivable progress of the great companies of the US and the world. So first let’s talk about short term costs.

Someone once said that success is the ability to go from failure to failure without losing enthusiasm. The quote is attributed to Churchill or Lincoln, or a self-help book for speech writers, or even the newsletter for the Carbondale Rotary Club. It doesn’t really matter. In no area of life is this more true than investing. I make two promises when I advise people to invest the preponderance of their portfolios in the great companies of the US and the world. The first promise is you will see prices decline in the short term.

It will happen often. Sometimes it will have been anticipated by a group of investors. Sometimes it will surprise all market participants. Sometimes it will be immediate and vicious. Sometimes it will be slow and grinding. The punditry will claim knowledge where none can be had. There will be predictions of our collective demise, at the very least the demise of our economy and our properly functioning markets. It will absolutely feel like they know something we don’t know, or at least know what they’re talking about. These feelings will be proven wrong in the fullness of time. They always are. No one will know when or how the decline will stop. No one will know beforehand the catalyst for recovery. No one will know how quickly markets will recover. No one will know how long the expansion will last before the next catastrophe. And it is not necessary to know any of these to be successful. While it feels like things are falling apart, all you need to do is hold on to your beautifully diversified shares of the great companies of the US and the world.

Successfully investing in the great companies of the US and the world is defined by the ability to go from one decline to the next without losing enthusiasm. Zooming out and looking at the history of markets will begin to see what we can expect. The gathering darknesses are visible in red. The inconceivable progress is visible in blue. You can’t time the turns, so to capture all the blue you must learn to sit through all the red.

Since the end of World War II, roughly the average lifespan of those nearing and in retirement. Today, the stock market, the marketplace that gives us the daily prices of the shares of the great companies we love across the US and around the world, has experienced an average annual entry year decline of just over 14%. A bear market, as classically defined minimum 20% decline averaging nearly one third 33% one year out of every four or six years. In my own category, a mega bear market, loosely defined as loss of greater than 40% every 15 to 20 years. These are averages. They have no predictive quality. There is no way to tell how the decline we’re experiencing in the moment will shape up. It is only after the fact that we know the details, and then the narratives we receive are always filtered through both bias and bullshit.

The first promise is you will see prices decline in the short term and the corollary it will not feel good. But the second promise is our topic for the day long-term benefit. What is the result of maintaining a commitment to owning shares of the great companies of the US and the world for decades? And, perhaps of greater importance, what is the result in terms of long-term potential of inheritable family wealth and philanthropy? In order to answer these questions, we will first create a case study based on five assumptions. We’ll describe a starting income, an age that we start saving, a savings rate. We’ll describe equity exposure and a retirement date. We’re going to pick some numbers and just run with them. Very good arguments can be made on both sides of each number we choose, which gives me a lot of confidence that we’re considering something that’s kind of a middle-of-the-road case study.

To those of you reading this, in New York, los Angeles, san Francisco Bay Area or in any metropolitan area, these incomes will seem small. These are the national averages. Regardless of the dollar amounts, the percentages will apply everywhere. First, starting income the median household income for households in the United States in 2022 was almost $75,000. If the highest level of education in the household was a high school diploma, the median income falls to $51,500. If someone in the household has a college degree, the median income rises to $108,000. So, for those just starting out, an entry-level job for a high school graduate in the US pays about $36,000 per year, and an entry-level income of a college graduate is about $59,000 per year. So for our purposes we’re gonna use the median income for a household with a high school diploma $51,500. This happens to also be in the middle of the average starting incomes for everybody. In other words, $51,500 is an entirely average starting point. We assume that household income keeps up with an estimated 3% inflation. This is very conservative. Household incomes have generally increased at a pace faster than the rate of inflation.

Second, we wanna talk about the age of initiating savings. So, according to the August 2023 study from the Milken Institute, the age that people start saving for retirement has been decreasing. This is a positive. The age has been decreasing with each new generation. The study tells us that the average age that boomers started saving for retirement was 35,. Gen X my generation started saving at 30, millennials at 25, and Gen Z, the oldest of which are in their 20s, started saving at 19 years old. So for conservative simplicity, we’re going to use the millennial starting age of 25 years old. Third, we gotta look at a savings rate. So these numbers are all over the map in a nod towards being consistently better than prior generations. The amount the millennials are saving in their early years is higher than older generations, so they’re saving earlier and they’re saving more.

For our purposes, we were gonna start low and then increase the savings rate over time. In their 20s, our household case study will save a modest 5%. In their 30s, as their income increases, they will increase retirement savings to 8%. In their 40s, they’re gonna do some simple planning and increase their savings rate to 12%. In their 50s, feeling behind the curve, as I know many people do, they will increase their savings to 15% and in their 60s, becoming concerned that they will either never be able to retire or run out of money in retirement, they will increase their savings a final time to 20%. There are a number of factors that make all of this possible. Income increases over time through job switches and raises. Single income households become dual income households and as we age we knock off big life expenses. You furnish the house once. You probably buy the house once. You might buy a second house or trade up to it. You send the kids to college, once you pay off the mortgage eventually, et cetera. Whatever the reasons, it’s normal for savings to increase as we age.

Fourth, equity exposure Now. For the last many weeks, I have clearly covered my reasons for preferring portfolios heavy in the ownership of the great companies in the US and the world over the last seven weeks. So it should not be a surprise when I use a 100% equity portfolio in this analysis. So caveat this is not a recommendation, it is just math. Every individual has to determine the right amount of equity exposure for them. You know my exposure. I’m not recommending this for anybody specifically, but this is the math. So we’ve already discussed the first promise that the portfolio consisting of equities will decline 14%, peak to trough on an annual basis 20% minimum, on an average of 33% every four to six years and over 40% one year out of maybe 15.

If you are invested in a 100% equity portfolio, you must expect this. This is normal equity volatility. Nothing is broken. If the share prices of great companies did not vary widely and quickly, then they would not provide the long-term returns we need to accomplish our goals. Volatility and return are two sides of the same coin. By removing volatility or simply dampening it. By including fixed income, you remove some portion of that long-term return. In most bear market cases the portfolio will have recovered within two years. Sometimes it will take a little longer.

Individuals should consider this recovery period when they set out to create an emergency fund. We always recommend a minimum of two years of gap expenses, defined as total expenses, less fixed income like social security, pension, et cetera. We expect that we would like to see that money set aside in cash upon retirement. So when the bear market comes, the emergency fund is an easy source of liquidity available outside, just in case a portfolio does decline, because it will, if one wanted to be a bit more conservative, make that emergency fund three years. If one wanted to be a little more aggressive, maybe one and a half years.

So the final variable in our case study is our retirement date. So currently, for everyone born after 1960, the full retirement age according to Social Security Administration is 67. Now I actually did this. I ran this scenario starting with 67, but the numbers worked so well that I decided that our sample household could retire a little earlier, at 65. So for the record, working until 67 or longer would just make the numbers better. So our case study.

This is our setup summary of our case study. We have a starting income $51,500, with a 3% annual increase. We start saving at an age of 25. Our savings rate at 25 is 5% and it increases through our lifetime as our income increases and our expenses actually decline. With half a mortgage, some of those bigger expenses go away. Our equity exposure is 100% outside of our emergency fund and our retirement date for this brief analysis is 65.

So I have often referenced an annualized average return plug number of 11% for small companies, 10% for large companies, and this is rough and rounded. According to the JP Morgan guide to the markets that anybody can look up online just Google JP Morgan guide to the markets, for the period of 1950 to 2022, the average annualized return for the S&P 500 is 11.1%. According to officialdataorg, the annualized average return for the S&P 500 from 1929 to present is 9.56%. This is what dividends were invested. For our purposes, we will use the lowest long-term average number among these. We’re going to assume average annual return is 9.56%. We’re going to review the results in three categories. First, we’re going to look at retirement asset results. Second, we’re going to look at retirement income results. Third, we’re going to look at legacy results First. Let’s look at those retirement asset results. The retirement assets that result from this simple setup are visible here.

Over 40 years magic. We can read this as compounding happens Starting with an income of $51,500 and saving only $2,500. At 25 years old, their retiring portfolio value is 2.75 million. This is the first result of a lifetime commitment to owning the shares of the great companies of the US and the world. Compounding is almost imperceptible at the outset. After 30 years, it boggles the mind. In the first five full years of saving, our household only saves $13,600, and the investment returns only add $2,300. In the final five full years of savings before retirement, our household investment returns alone are over $700,000,. As more money accumulates, the curve steepens. If, instead of retiring December 31st of their 64th year, our household would have worked one additional year, they would have added an additional $33,500 in savings and their portfolio would have grown on average by almost $238,000. This is why Charlie Munger and Warren Buffett talk so much about the importance of compounding.

Warren and Charlie set an interesting aspirational example for us. They’ve both been incredibly financially successful. They also both pursued something they loved and they found in each other a best friend with whom to pursue it, with Neither of them ever retired to draw assets from their portfolios. So they’ve both been growing and compounding their wealth for 80 years. That’s two times the norm. Much of their success stems from their 80 plus years of compounding. Their wealth was not created by timing the market. It was created by time in the market.

If our household could do the same thing pay their bills from another source and never draw from their portfolios for another 40 years, it would look something like this yes, you’re reading that right. This is an estimated portfolio value of $100 million through compounding alone. They don’t add another penny from 65 onward, but they don’t withdraw anything either. They just leave the portfolio to simmer for an additional 40 years. The final year of the portfolio, the investment return would be almost $9 million. For context, that one year return number is almost four times the total portfolio value, the year they would have retired at the age of 65. That is the steepening of the curve that is compounding. This is what Warren Buffett was talking about when he said my life has been the product of compound interest.

Now let’s turn our gaze to retirement income results. Our household started with $51,500 of income in their 25th year, having worked, saved and accumulated, as we have shown, above their entire working lives, having decided not to work forever, as Buffett and Munger have done, they will retire in their 65th year. At the start of their journey, they spent $49,000 of their $51,500 income to live. Having saved only $2,500 that first year In their 64th year, the last full year before retirement, their living expenses were $130,500. We’ve assumed that they have spent every penny not committed to retirement savings their entire lives.

We know, as described in Versus the Gathering Darkness, part 5, growth of income, that a portfolio of great companies with rising profits and rising dividends is the very best way to create a retirement income they can’t outlive. However, even with the great compounding power of the great companies and their dividends, the initial withdrawal rate is very important. This is a withdrawal rate that has historically been considered safe. Knowing this, they have agreed to cap their portfolio distributions at 4.5 percent of their portfolio value on an annual basis. Remembering their retiring portfolio value is 2.75 million, 4.5 percent of that number is 124,000. This is only 95 percent of their previous year’s expenses and they are committed to not drawing more than the 4.5 percent. Maybe life is less expensive when they’re not working. Maybe they drive for Uber, get a part-time job to make up the additional 5 percent, or maybe they take Social Security a bit early.

Whatever path a retiring household chooses to align their income and expenses in the short term would not have to last long. The 4.5 percent portfolio distribution grows more quickly than their lifetime expenses. By the sixth year of retirement, the portfolio income has surpassed lifestyle expenses. By the 20th year, the 4.5 percent portfolio distribution is 25 percent higher than our lifestyle expense trajectory. This is what that looks like. An income stream that rises to exceed your rising cost of living is the second result of a lifetime commitment to owning the shares of great companies of the US and the world.

Now let’s turn to the legacy results. First, owning shares of the great companies of the US and the world created a portfolio of assets at the time of retirement, the income from which almost entirely covered their current living expenses. Second, owning shares of the great companies of the US and the world created an income stream during retirement that increased faster than their rising cost of living. This obviously gives the household choices. They can spend more, maybe travel more, help the kids more or simply be more charitable, or they could leave the unneeded additional income in the portfolio to continue to simmer and grow as part of the legacy results. For our purposes, we assume that they spend every bit of their 4.5 percent distribution, enjoying life to the fullest for the rest of their lives Leading up to their retirement and then during the early years of retirement, our household was working diligently to save and invest, focused solely on supporting their own later years and not being a burden on their children.

At some point as our households, children grow into adults and have children themselves, the success of their accumulation plan begins to dawn on them. As they meet their grandchildren and experience the joy of three generations for the holidays, they begin to consider the impact their accumulated wealth might have on their children, their grandchildren and their yet unborn great-grandchildren. They worked hard, they scrimped, they saved. They invested simply but patiently in shares of the great companies of the US and the world. They spent the early decades worrying that they would never have enough. They increased their savings to fill the gaps and remained committed to owning great companies through whatever the markets throughout them.

In the early years of retirement they spent all the dividends and some small portion won 2% of their principal as it grew in value. They hated touching principal, but they needed the money to live. After a few years because they committed to that 4.5% cap on their distributions, they see the growing dividends cover a larger and larger share of their income needs, while the percentage drawn from their principal declines as more years pass. The growing dividends cover all of their living expenses, which leaves the principal to grow more quickly. Eventually they recognize that they are unable to spend all the dividend income they receive. Their excess dividends are reinvested to grow the principal ever more quickly.

The continued compound earnings and retirement and the continued growth of their income stream beyond their own need all but forces them to stop looking at money as a finite resource. At some point they cease to worry about their own income and in this moment they are transformed. They are no longer the owners of the shares of the great companies of the US and the world. They are the stewards. It is no longer a portfolio of assets they manage worriedly and self-interestedly for their own spendable income, which has become a foregone conclusion. At this point, as my friend Nick Murray has said, they awaken to the fact that their wealth is a river capable of growing deeper and wider as it flows downstream to the next generation. This chart we’re showing now is the growth of the retirement assets less the 4.5% distribution for the remainder of the retired couple’s lives. Entering retirement at 65 with 2.75 million, capping your distribution amount at 4.5% and remaining committed to the ownership of the great companies in the US and the world will, in the fullness of time, create legacy wealth that is not just transgenerational but multi-generational the river compounding for the next generation. This is a beautiful topic.

At some point, this fantasy couple that started saving $2,500 when they were just starting out, at 25 years old and committed to everything described above, will die and they will leave their children and grandchildren with the assets and the income stream to support their maintaining the river for the next generation and the next and the next. We can’t know in advance when someone might die, but if someone were to follow this path exactly as we described it, there is a range of potential outcomes. If our founding household were to die at 85, this is the middle third of the top line they would likely have children around 50 years old and grandchildren in the mid teens. At this point they will be at about $7.1 million wide and deep and the family would be drawing 4.5% or $321,000 from it in a safe manner. If the founding household live to 105, this is the left third of the lower line they would likely have children in their 70s, grandchildren in their mid 30s and potentially great grandchildren in the early single digits. At this point the river would be $17.65 million wide and deep and the family would be drawing the same 4.5% now worth almost $800,000 in a safe manner For the entirety of this first generation’s retirement.

The assets continue to grow while it spins off their retirement income. So long as the subsequent generations maintain the commitment to both owning the great shares of the US and the world and drawing less than 4.5%, the assets will continue to grow from generation to generation and continue to provide an ever-increasing source of income. Each generation becomes a steward of capital that serves the family across many generations. Obviously, this requires a systematic cross-generational education program. It belongs to no one but all our caretakers. The river grows, so the 4.5% distribution grows. So long as the family maintains the twin commitments to the ownership of the shares of the great companies of the US and the world and the 4.5% distribution cap, the river will continue to widen and deepen as it flows. The widening and deepening river is the legacy result of the ownership of the great companies.

So I’m going to just quickly summarize. The first result of our commitment to owning shares of the great companies of the US and the world for our entire working lives is the attainment of enough the creation of a pool of assets that supports, or nearly supports, our first year retirement income. The second result of our commitment to owning shares in the great companies of the US and the world during our retirement is an income stream that rises to meet and then ultimately exceed our rising cost of living and lasts the rest of our lives. The final result of our commitment to owning shares of the great companies of the US and the world for our lifetime is personal transformation. As we realize that we have an income stream that rises first to meet and then exceed our living expenses, and also a pool of assets that continues to grow year in and year out. Our role vis-à-vis that pool of assets begins to shift. At some point, we see it, upon our death, we will have the largest pool of assets we have ever held in our lives. At this point we set the worries and fears for our own retirement incomes aside and we embrace the stewardship of our family’s financial future the river. If we but train subsequent generations to love owning shares of great companies and limit distributions to 4.5%, then each generation will have access to the river, both the rising stream of income and the rising pool of assets. This is how a family with a modest income can slowly but inevitably build wealth that lasts across generations. This is available to all of us and it is easier to implement today than it has ever been in our history together on this planet.

And there are three things and we have to cover these things. There are three things that can go wrong. The three points of failure, sort of in order of importance, are these First, panic. Panic is the human response to volatility and I’ve said this before, I now say this again. This requires this whole enterprise, requires a commitment to owning the shares of the great companies of the US and the world. This is not a sometimes things, it is an always thing.

The result we have advocated here these are only possible to the family who buys and holds and does not interrupt compounding. We can’t sell because it feels bad and then buy back later. That interrupts compounding. We can’t sit in cash and wait for the market to give us an all clear signal that interrupts compounding. When we have money to invest, we put it into the river. When we need money, we draw it from the river, always capped at that 4.5% per year limit. Helping you and your family maintain this commitment is the greatest value offered by financial coaches and advisors anywhere. Just as a fitness trainer will get you to run that last mile, that last most difficult mile, or lift that final, most difficult rep, a financial coach can help you increase your exposure to the great companies of the US and the world at the outset and then hold on to those shares of the great companies of the US and the world.

When it gets hard, during times of perceived crisis and catastrophe, the generation that panics out stops the compounding for all future generations. Avoiding panic is the first requirement of multi-generational wealth. The second requirement you’ve got to train the next generation. For the legacy result to work, you have to train the next generation in everything I have presented these last two months. They must embrace the ownership in great companies in the same way you do. If they do not, they will succumb to the gathering darkness and they will interrupt compounding. If you can embrace the ownership of the great companies of the US and the world, you will be able to create the first result, enough and the second result the rising income stream that exceeds your rising cost of living and lasts the rest of your life.

However, the final result multi-generational wealth creation requires training the subsequent generations. It is not enough to hear and understand the gathering darkness and versus the gathering darkness as I presented it. You must fully embrace the next generation’s education and a little light indoctrination in these messages as well. It is not enough for a quarterback to train in throwing a ball the receiver must train in catching it as well. It is not enough for the pitcher to throw an excellent pitch the catcher must know how to catch it. It is not enough for the winger to place an excellent cross the striker has to know how to head it into the back of the net. Leaving a legacy, one that has the potential lasting across generations, requires a systematic training that will teach the next generation and teach the next generation how to teach the following generation.

The third thing to support this process planning and taxes. Now, these are a moving target. In order to get the savings numbers and the portfolio design right at the outset, there needs to be some simple planning done Along the way. There will also need to be some consideration of legal structures to protect assets from income taxes and estate taxes, and, though each family is different in how they wish to handle this, one may also want to consider trusts and vehicles that protect the family’s legacy from divorce and other legal proceedings. Additionally, in many cases, people will likely be saving into retirement accounts. These may not be the best things to leave across generations, because money and traditional IRAs 401ks, 403bs, tsas and the like will be taxed more heavily upon distribution. They’re also subject to required minimum distributions, and the Secure Act of recent years nearly eliminated the ability to stretch retirement accounts across the lives of your heirs, meaning the taxes are due and payable more quickly than they were before.

You may want to consider, instead of superfunding your retirement accounts, investing in a taxable investment account that would benefit from the stepped up basis upon your death. These rules are always changing. If you seriously want to create a river that grows wider and deeper as it flows and enables the transfer of wealth across generations, then you must engage continuous deeper planning. As always, I welcome your thoughts on the ownership of the great companies in the US and the world. Next week, I’m going to answer the big questions. I’m hearing and I assume is on your minds, jonathan. When you say own the great companies in the US and the world, which companies are you referring to? Until then, thank you so much for listening and happy investing.

0:35:13 – Jonathan DeYoe
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