Weston Wellington from Dimensional Fund Advisors in his latest Down to the Wire commentary has provided a fascinating case study about an unlikely millionaire in the USA reminding us all of the power of compound interest.
The Millionaire Next Door
The Chicago Sun-Times recently reported that Grace Groner, a long-time resident of Lake Forest, Illinois, passed away in January at age 100, leaving a $7 million bequest to her alma mater, Lake Forest College. Although Groner lived in one of the country's wealthiest communities, she hardly fit the profile of a trust-fund socialite. An orphan at age twelve, she was cared for by neighbors and attended college, earning an English degree in 1931. She went to work as a secretary for nearby Abbott Laboratories in Chicago where she worked for forty-three years. She never married, never owned a car, and lived for much of her life in an apartment before moving to a tiny one-bedroom house willed to her by a friend.
Her $7 million estate was the fortuitous result of a lifetime characterized by frugality, simplicity, and a large dose of good luck. She had purchased three shares of Abbott stock for $60 each in 1935, reinvested the dividends, and never sold them. Over the subsequent seventy-five-year period, her three shares multiplied to well over 100,000, and her $180 initial investment grew over 38,000-fold to approximately $7 million.
This story brings a smile to almost everyone's face and offers a number of investment lessons as well.
- Compound interest is a wondrous thing over long periods. To turn $180 into $7 million over 75 years requires an annualized return of 15.13%. By comparison, a similar investment grew to $3,046 in one-month US Treasury bills, $389,669 in the S&P 500 Index, and $10,435,007 in US small cap value stocks. (Annualized returns were 3.84%, 10.78% and 15.75%, respectively.) Over the long run, a little extra return goes a long way.
- Maintaining an investment strategy requires discipline, detachment, or some combination of both. Ms. Groner had ample reason over seventy-five years to question the wisdom of holding Abbott shares, and by extension, equity investments of any kind. The shares lost roughly one-third of their value in the bear market of 1937, for example, and did not exceed the mid-$50 share price of March 1937 until March 1944. She continued to hold her shares despite plunging stock prices in 1962, 1970, 1974, 1982, 1987, 1990, 2002, and 2008.
- In the wake of the recent financial crisis, lecturing investors on the possibility of so-called "black swan" events has become a popular pastime for authors and financial journalists. There is certainly some truth to their observations; as Gene Fama pointed out in his Ph.D. thesis published in 1965, stock returns exhibit extreme outcomes much more frequently than that predicted by a normal probability distribution. Ms. Groner's experience illustrates how some unanticipated "black swan" events can be remarkably good.
- Could you recognize a great growth stock even if you owned it? It could be harder than you think. The most striking characteristic of Abbott's share price behavior over the past seventy-five years is how long periods of trendless or below-average performance are punctuated by brief episodes of sensational results. As an example, the 1950s were a rewarding decade for equity investors, and the Dow Jones Industrial Average more than tripled in value. But Abbott shares rose only 22.7%. How many of us would have had the patience to continue reinvesting dividends into an "obvious" loser after such a long drought? The same argument applies to holding an asset class such as small cap stocks or real estate after a prolonged period of weak relative results.
- Should we seek to emulate Ms. Groner's success by making a bet on a single company? Probably not, particularly if we are seeking to use our portfolio to fund retirement expenses. Although we may admire her habit of thrift, most of us would have a hard time riding the bus for decades and wearing second-hand clothes while maintaining a multi-million-dollar portfolio. If her investments had done poorly, the loser would have been Lake Forest College, not Ms. Groner's lifestyle.
- A major factor in Ms. Groner's success is a happy accident of geography. She was raised in Lake Forest and went to work for a firm in nearby Chicago that turned out to be one of the biggest winners in the entire US equity universe. For the fifty-year period ending in 2009, for example, only seven stocks had higher rates of return: Altria Group, Kansas City Southern, Loews, Walgreen, RadioShack, Dover, and Johnson & Johnson. But if she had chosen to work instead for other industrial leaders of the time such as DuPont, National Steel, or Nash Kelvinator—all components of the Dow Jones Industrial Average—the outcome would have been sharply different.
The moral of the story: Albert Einstein may or may not be the source of the quotation, but it appears that compounded interest truly is the "eighth wonder of the world."
John Keilman, "A Hidden Millionaire's Gift," Los Angeles Times, March 6, 2010.
David Roeder, "One Woman, Three Abbott Shares Equals $7 Million," Chicago Sun-Times, March 7, 2010.
Eugene F. Fama "The Behavior of Stock-Market Prices," Journal of Business 38, no. 1 (January 1965): 34-105.
Center for Research in Security Prices, University of Chicago.
