In the 5% to 9% return range, the added benefits of beating the market are meager. I don’t know about you, but working really hard for over a decade to achieve a goal 1 or 2 years sooner doesn’t sound like much of a reward to me. In my case, perhaps I’d get to retire mentally exhausted at 50 instead of almost effortlessly at 52, which is what I did.
On the other hand, these same graphs neatly illustrate how important it is to get a decent market return using stocks instead of the relatively poor return available from bonds. Bonds are expected to return somewhere around 2% in the next decade. So, it would take you 35 years to double your money with bonds, as compared to 14 years (less than half the time) with a 5% return from stocks. Now that’s a substantial time savings to achieve an investing goal.
More Realistic Goals
I considered just stopping here, but I worried some readers might comment that doubling their money is not a sufficiently ambitious long-term investing goal. After all, many people invest for much more than a decade or two that it might take to double their money. Accordingly, let’s look at the same graphs for the goal of increasing an initial one-time investment by an order of magnitude (a 10 times increase).
Using the estimate again of 5% future expected stock returns, it would take more than 47 years to increase your money by one order of magnitude. If you tried really hard to get a 6% return instead, you’d reach your goal about 8 years sooner. That sounds like a significant amount of time. However, in my view, if you’re willing to wait nearly 40 years to reach a goal, achieving the same goal in under 50 years still seems satisfactory. And if the market return for stocks ends up in the 6% to 9% range, the margin of time saved by seeking excess returns decreases rapidly to between 2 to 5 years out of several decades.
An Even More Realistic Scenario
Again, if I left it at that, I’m sure a few readers would think that potentially reaching a life-long investing goal up to 8 years sooner is a good enough reason to pursue excess stock returns. Although the above calculations provide useful illustrations of how compounding works over time, they contain an important simplification.
In fact, very few investors plunk down a one-time lump sum and then watch it grow untouched over many years. Most people save and then invest small increments at regular intervals. The classic example is depositing part of each paycheck into a 401K or IRA account over a working lifetime.
So, let’s look at the 10-times investing goal again using the more realistic scenario of saving and investing over time. Specifically, let’s say you invest $10,000 at first, but you add $10,000 per year in monthly increments that come from each of your paychecks. Here are the same two graphs for that scenario assuming monthly compounding.
Pay close attention to the vertical axes here. Even with a 1% return rate, it takes less than 9 years to amass 10 times the initial investment. That’s a blink of an eye as compared to the 230 years it takes to reach the same goal at the same return rate in the one-time initial investment scenario! When you include savings, seeking excess returns of one or two percent reduces the time to reach an order-of-magnitude goal by less than a half a year for all rates of return. That is, the time you save seeking excess returns is entirely inconsequential.
This may seem trivial to some readers. After all, if you save $10,000 per year and hide it under your mattress, you’ll have $100,000 in 10 years. Trivial or not, this comparison puts the issue of investing in the proper perspective, which is:
- The most important decision you make about investing is still less important than relatively trivial-sounding decisions that help you save more and save consistently.
Further, the math is clear that seeking excess returns is probably one of the least important decisions within the relatively unimportant realm of investing in general. If you’re going to seek an excess of something, strive to save more tomorrow than you saved yesterday. That way, you’ll arrive at your goal faster than the best investing plan you could ever devise.
Of course, the math changes if we talk about a larger initial investment (like a million dollars) with relatively small regular savings of something like $10,000 per year. But I’d argue that the scenario of relatively small consistent investments starting from a relatively small initial sum represents most individual investors. It certainly reflects my investing history and that of my friends and relatives.
Conclusion
These calculations reveal that, like many aspects of investing, what counts most is how you view the process. You can take the view that you missed out on something because you didn’t get that extra 1% in returns over the last 10 years. Or you can take the view that you’ll get to your goal anyway in just a few more years. Mindfulness is all about slowing down and being content with what’s happening now. A mindful view means you’ll be less stressed along the way, less likely to make costly investing mistakes caused by striving for more, and you’ll arrive at your investing goals soon enough.
Some people may say that I’ve made a false assumption, because pursuing excess returns is not necessarily difficult and stressful. Some may say they even enjoy the process of hunting down those hidden opportunities that most investors miss. If you’re one of those people, then I say, more power to you.
But before you continue into that forest, be sure to consider how you’ll feel if your hunt for excess returns fails to beat the easy returns available from a simple all-market index portfolio. As I’ve pointed out many times, the vast majority of professional and individual investors fail to beat the market. Like Actaeon, they go from enjoying the hunt to regretting it. I hope all the “fun” you have during your hunting adventure sufficiently soothes the pain you’ll feel when excess returns elude you, and you realize you’ve wasted time instead of saved it.
For more fixed-income trends, visit the Fixed Income Channel.