Hung Up On Returns?
Hung Up On Returns?
Are we hung up on returns? I often wonder that as I listen to the arguments for and against different investment classes. Index funds vs stock picking. Owned real estate vs REITs. Dividend stocks vs bonds. There are so many different controversial subjects to touch upon. And each methodology has its own proponents. It certainly can leave the novice investor befuddled and confused. Is their a definitively correct path?
I am far from perfect. I am not an investing expert. Yet, year after year, I seem to do okay.
Timing The Market
Imagine two index investors. They hold the same index fund. Put together by the same company. They pay the same fees. Yet one of those investors is going to reap a 15% average yearly return while the other is going to have a negative return. Want to know the difference?
Simple, it’s timing. Get into the market at the wrong time or be forced to sell assets in a downturn, and you are likely to have much worse results than your peers.
Assuming that you invest in assets that have reasonable growth potential, you are more likely to get stung by bad timing, and less likely by not being such a good stock picker.
We get hung up on returns all the time. But maybe we should focus more on creating optimal timing. Especially when exiting the market. It is harder to optimize entrances.
Horizon
You know what makes a successful investor? Longevity. Again, this is assuming that one has invested in companies and assets that have reasonable growth potential. As long as the companies, governments, or entities that hold your money stay liquid, it’s hard to lose over long time periods.
Index funds. Well picked stocks. Reits. Rental properties. In general, they all build wealth nicely over long time periods. You can get hung up on returns if you want. Shoot for an 8% return over a 7% if that makes you feel more wealthy. But in the end, you will likely succeed if you just hang in there.
The W2/Business Asset class
You know how people really build wealth quickly? They earn it. Income is one of the best ways to build net worth. Why? Because it costs very little. In order to invest in an index fund or or a rental property, my original equity is consumed in the investment. My ten thousand dollars can only make a small percentage of its value when it is invested.
When I work, however, I start with nothing and end with something. I can get hung up on returns all day. But the petty percentage differences in differing asset allocations is nothing compared to what I can make with a few good hours of hard work.
I need millions of dollars of investments to generate what I make each year with zero equity at risk within the W2 and business asset classes.
It just takes a little sweat equity.
Perfect Is The Enemy
And then, of course, is my belief that perfect is the enemy of good. The amount I make each year on my investments is good enough. It supports my life style, allows me to pursue my half retirement, and provides for our family.
Would life be much better or even different if I optimized myself up to making an extra 1% a year?
Financial independence is quite reachable for most even with lower than average returns. Especially if you focus on income generation and frugality. Compounding has a few main factors. If you feed the beast enough fuel and stoke the fires for long enough, suboptimal heat will still be sufficient to cook a pretty fine dinner.
Final Thoughts
While I never look a gift horse in the mouth, I also try not to get too hung up on returns. I would rather focus on timing, horizon, and generating income. For me, perfect is the enemy to good. There are many ways to take advantage of compounding. Total returns is just one spoke.
What you describe is illusion. An index fund by definition is an investment in an economy, by the purchase of property. The property has a variable value set by a market mechanism, IT IS NOT MONEY. It is property. You acquire wealth in this system by purchasing more property. Day in day out year in year out. You don’t make a killing if you are not in the market. This is why DIY investors tend to be idiots. They are too busy worrying about when to get in and when to get out. I have read studies that show the average DIY looses 4%/yr on his investments over an optimized investment schedule by playing this odds game of shaving an extra point on entry. That means if you have 100K to invest and that money sits in a 0.1% bank account unexposed to the market it actually looses you money since inflation is 2%. The “money” only makes profit if you turn it into property exposed to the market, at that point your “money” acquires risk and that is why you get paid, for the risk you take. No risk No return and in fact no risk = loss. Your return and the risk you take in passive index investing is virtually entirely dependent on the economy, not on you. The only thing you add to the return is your stupidity at pretending you know what you are doing. If you’re a flea on a dog, it mattes not if you live on the head or the tail, both carriages gets you to the same address. The solution to passive index investing is a mechanical portfolio, and that is dollar cost averaging. What dollar cost averaging affords is you get available investment money turned into property PRONTO not wasting a second because you ONLY make return when you acquire risk otherwise you are sucking wind. If you have 100K to invest and you dollar cost average that 100k your a moron. You do not know what you are doing because you ONLY acquire return when you acquire risk so you want to acquire risk immediately. A 100K purchase of property in a 5M portfolio is trivial it is 2%. If you buy 100K worth of property and it drops to 75K equivalent value next week BFD. If the market is expected to return 10% and your cash is expected to loose 2% and you don’t invest YOU’RE DOWN 12% guaranteed. If the economy is not deflating (like Japan in the 1990’s) but in over all expansion, the economy will take care of your investment tail or head the dog will move you forward.
This is also why rebalancing is important. Rebalancing forces you to constantly sell some high assets when they are high in a mechanical fashion. Every year on the way up a little profit gets siphoned off for the day when the market tanks. When the market tanks you therefore do not have to sell your risk assets on the cheap but can live off some previous years profits, or you can then supercharge your risk assets by using the siphoned money to buy new risk assets low. This is the only market timing you should participate in because it gives you asymmetric risk management. In the bad time you have an alternative source of income beside your risk assets. If the economy recovers you will also recover. That’s how passive investing works and if you think you can outsmart it, you’d be wrong. Your goal as a passive investor should be to NOT LEAVE that 4% on the table! By choosing passive index investing by definition you have resigned yourself to average return PERIOD FULL STOP. You can improve your return by controlling your risk. The reason that happens is in a downturn the more risk you own the greater your loss will be. If the S&P drops in half and you own 2/3 the risk of the S&P you will drop only 33%. For the S&P to get even requires a 100% gain. If you own a 33% loss you only need 66% to get back even. That will happen much sooner than a 100% gain which means you will be compounding again long before the S&P guy gets even. You gain risk management through NON CORRELATED diversity. The most general non correlation is between stocks and bonds. You gain very little risk abatement by owning a variety of stock funds. In a downturn the correlation in ALL stock funds tend toward 1.0 and if you own riskier funds you will have a 1.0 correlation and a worse result than if you owned less risky funds, to wit the Bonds have 3.5% risk, S&P has a 15% risk, global stocks has a 17.25% risk and REIT has 21% risk. You can see if you own a bunch of global and REIT you own a bunch of extra risk and it turns out the return for that extra risk is not commensurate. If you look at your portfolio as something that provides return, you pa for that return by the amount of risk you hold, and if you hold a lot of risk and that risk doesn’t pay you a lot more in return then your portfolio is VERY EXPENSIVE to own. This is why I don’t believe in the BH3. You clearly pay for your return with way too much risk.
The other point that is illusion is the idea that work doesn’t cost you anything. Work costs you your human capital. It is NOT FREE. The excessive expense of human capital pushed to its limit is why people suicide and is the source of burnout. You may be willing to spend your human capital on work, but if you have enough you are wasting yourself and you will never know peace. This is why spending your human capital feels like you are being consumed. It is a consumptive process and the notion that is “nothing” is simply denial. It is a simple risk reward calculation as well. I retired when I realized another million bucks made zero difference to my future, so at that point I realized all working was giving me was greater and greater risk. 6 months later I was OTD.