By JLP | January 29, 2008
What could possibly be better than a 20% return on your money?? I’ll tell you, and it isn’t a gimmick.
Investor 1 wants to do right by herself and her money. She’s worked hard to stash away $1000, and she’s determined to maximize her return. So over the course of a year she spends much of her time online researching stocks. She keeps up with all the news, trades often, and is alternately exhilerated and stressed with every volatile turn in the markets.
She does well and earns a 20% return – even after taxes and all those trading fees! At the end of the year her $1000 has turned into $1200. She smiles and pats herself on the back. Then she flips on CNBC to see if she can pick up some tips on how to duplicate that return next year.
Investor 2 also worked hard to stash away $1000. She too wants to do what’s best for her financial future by making that money grow as fast as possible. Therefore she sticks her $1000 in an index fund. She knows this will minimize fees and taxes and – more importantly – that she can just let that money sit there without having to spend a lot of time tracking the markets, trading stocks, or doing research.
She’s diversified, and at the end of the year she has returned 8% on her money with little to no effort. She smiles, satisfied, and knows that over time she’ll probably end up averaging that return.
AND THE WINNER IS…
Investor 2! [trumpets blare] So wait–why is Investor 2 better off than Investor 1!? No, not because she’s taking the slow and steady route to win the race, and not because she appears to be more sensible than Investor 1 or because she better manages her time and values balance in her life (although those are all good reasons).
Investor 2 wins simply because she ended the year with over $1,700 while Investor 2 only had $1200 in her account. “What?!” you cry. “But Investor 2 only made 8%; how can she end up with $1,700??–that’s a 70% return!” Good catch by you. I left out one detail: Investor 2 managed to put away an additional $50 a month during the course of the year. She used her extra time not to chase returns on the latest booming sector but rather to make lunches for work, learn to effectively grocery shop, mow her own lawn instead of pay the neighbor kid, and cook dinner more often.
The Moral of the Story
OK, so if she actually did all those things she could have saved a lot more than $50/mo. She could have spent all her free time playing Guitar Hero 3, but the point is that putting away more money is a whole lot more effective than trying to maximize your return.
YOUR RETURN DOESN’T REALLY MATTER
Caveat: Ok, so once you have over $1,000,000 in investments your return starts to matter–and at that point it matters a LOT. The difference between an 8% return and a 10% return is $20,000 a year when you have a million in the bank. But if you have $100,000 the difference is only $2,000.
Sure, $2000 is a lot of money, but it’s only $166 a month. That’s not exactly worth paying expensive financial advisors, racking up trading commissions and taxes, or being chained to the Wall Street Journal and CNBC to track your bet-of-the-week.
Why not just accept market returns, keep saving, and enjoy your life?
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