Search


Subscribe to AFM


Subscribe to AllFinancialMatters
by Email

All Financial Matters

Promote Your Page Too

The American's Creed

Site Sponsors

Books I Recommend


AFM in the Media


Money Magazine May 2008

Real Simple March 2008

Blogroll (Daily Reads)

« | Main | »

What’s Better Than A 20% Return?

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
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
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?

More from Meg at The World of Wealth

Topics: Index Funds, Investing, Personal Rate of Return | 11 Comments »


11 Responses to “What’s Better Than A 20% Return?”

  1. Dr J Says:
    January 29th, 2008 at 12:02 pm

    well written.

    its good to always read this type of thing again and again to remind us all the being “rich” is more than just having money and that making “smart” investments doesn’t mean getting a huge return

  2. Zulu Says:
    January 29th, 2008 at 12:19 pm

    It could be argued that, for some, the constant attention and every-day manipulation is as much a hobby as Guitar Hero.

    Additionally, with $1k as the starting amount, investor 2 wins. However if the initial amount is … let’s see, where’s my calculator … $5000, then both investors come out even. Anything over that and investor 1 wins.

    I understand what you’re getting at, but the example is a bit contrived. I take the approach of investor 2, but that’s more for the other reasons (time/values balance) than because the difference in return is negligible.

  3. moneymonk Says:
    January 29th, 2008 at 12:41 pm

    The Moral of this story is…to work smart, not hard

    Good post Meg!

  4. Eric Toya Says:
    January 29th, 2008 at 1:31 pm

    Tricky, tricky, tricky. Of course, the other question is how did Investor #1 do the next year? The “I beat the markets” refrain was common in the late 90s. You didn’t hear much from those same people a few years later.

  5. Mrs. Micah Says:
    January 29th, 2008 at 1:54 pm

    I like your perspective on this. For most of us, earning more in other ways is just as important as earning more through investing. If I had a million bucks, of course, I might be more focused on maximizing it. But I don’t and most of your readers don’t.

    Plus, money you earn/save is real money. In comparison, hot stocks aren’t always hot stocks and you could end up with lower returns.

  6. Early Retirement Extreme Says:
    January 29th, 2008 at 7:20 pm

    The crossover depends on how much principal one has stashed away and how much money is saved on a regular basis. In the beginning the biggest bang for the buck can be had in increasing savings and earnings. Once principal exceeds monthly savings by a factor 50 it’s definitely the ROI that is the most important.

    One can simply divide surplus returns with the amount of hours spent doing so to get an “hourly wage”. Similar divisions can be done for ways to save money. Then there’s the quality of life associated with it. If I’d make $6/hr flipping burgers and only $5/hr investing actively, I would probably pick the latter “job”.

  7. Dan Says:
    January 29th, 2008 at 10:06 pm

    Perhaps, but other things being substantially equal, your return is quite critical.

  8. MossySF Says:
    January 30th, 2008 at 2:10 am

    I’ve been investing for more than a decade and I find my contributions still far outstrip my market returns.

  9. The Simple Dollar » The Simple Dollar Weekly Roundup: Total Trust Edition Says:
    January 30th, 2008 at 8:02 am

    [...] What’s Better Than A 20% Return? Big returns don’t matter much if they’re positioned on top of an unstable financial lifestyle. (@ all financial matters) [...]

  10. Do You Need A Little Balance When It Comes To Matters Of Personal Finance? Says:
    February 1st, 2008 at 11:29 pm

    [...] Meg from the World of Wealth and All Financial Matters recently wrote a very interesting article about investing, saving, and ‘having a life’.  I encourage you to click over and read the entire article, the final line of which I’ll quote here – [...]

  11. Shaun Rosenberg Says:
    December 22nd, 2008 at 2:43 pm

    I think you forget about compound interest. In the long run investor 1 still wins.

    Say investor 1 manages to get an average of a 20% for 30 years without depositing another penny, after 30 years she will have 190,049.64.

    Investor 2 on the other hand continues her plan and saves $50 a month with an annual return of 8% after 30 years she will only have 80,977.95.

    Once more it is not to say you can’t both chase high returns and save money. A 20% return can be made with as little of 5-10 minutes a day checking and readjusting your positions.

    http://www.stocks-simplified.com

Comments