Buffett Thinks You Can Turn $400 Into $400,000, But Here’s The Reality

May 3, 2018

Buffett Thinks You Can Turn $400 Into $400,000, But Here’s The Reality

Buffett recently gave an interview where he discussed how if he would have invested the first $114.75 he made in 1942 in the S&P 500 and reinvested the dividends, he would now have $400,000.

That’s a nice way to sell the stock market to people, but I really disagree with Buffett and with what he’s selling. Today, I’ll discuss reality.

Nobody Has A 75-Year Investment Horizon

Buffett’s goal in life was just to accumulate capital and be the best investor in the world. He achieved that, but I’m sure that isn’t the goal of 99.9% of us. We want our money to work for us so that we can spend the extra money and have a better life or better retirement thanks to our investments, but 75 years is a bit too much. Therefore, we have to see what the best risk reward investments are for a 20 or even shorter investment horizon. But let’s see how Buffett’s advice to invest in the S&P 500, something he has never done, holds over shorter periods of time.

Shorter Term Investing – Shorter Than 75 Years

Let’s look at the distribution of 10-year returns over the last 139 years of S&P 500 available data.

Figure 1: S&P 500 10-year real returns including real reinvested. Source: Authors’s data.

In 18 out of the 139 cases I analyzed, real 10 year returns with reinvested dividends would be negative with the worst case scenarios being a 30, 32, and 35% loss if you invested in stocks and reinvested the dividends in 1964, 1910, and 1999. So with dividend reinvesting, we can say that there is a 13% chance that you will achieve a negative return over the next decade. The CAPE ratio was at 40 in 1999, 21.6 in 1964, and 14.02 in 1911.

The best 3 returns are a 416, 388, and 361% return from 1919, 1948, and 1918 respectively when the CAPE ratio was  6.63, 10.42, and 6.09 respectively. I’ll analyze the average returns for CAPE ratios in another article, but let’s look at 20-year returns and what Buffett has been saying.

Figure 2: S&P 500 20-year real returns including real dividends reinvested. Source: Author’s data.

Over 20 years, things already look much better as the worst returns are 14, 15, and 21% coming from 1961,1901, and 1902 when the CAPE ratios were 18.97, 20.94, and 22.3.

The best returns are 1,014, 924, and 918% from 1947, 1978, and 1979 when the CAPE ratio was 11.74, 9.24, and 9.26.

So, when the cape ratio is low, the chances for great returns are higher and vice versa.

Back to Buffett, his nominal returns from the period he picked would be around 11% per year since 1942 which is remarkable as the average 10-year real returns and 20-year real returns were 7.6% and 7.2% respectively. If I invest his $114 over 76 years at a 7.2% real interest rate, I get to $22,475 which is 20 times less than the story he tells. It’s not bad, but keep inflation in mind when looking at those huge numbers.


So, with reinvested dividends, the S&P 500 has delivered real, thus inflation adjusted, returns of around 7.4% per year with huge variations.

My point is that if you have a 20 year investment horizon, which there aren’t many out there who do, you can expect positive returns but don’t expect to win the lottery as the current CAPE ratio is above 30.

The problem is that few can diligently reinvest those dividends and forget about their investments. Unlike Buffett, we all have lives. Keep that in mind when investing and also keep in mind what happens to your life if you do reinvest the dividends and when your average annual return over the next 20 years is just 0.6% as was the case in the worst historical 20 years for the S&P 500.