I was listening the other night to a talk about testosterone and investing, and why this isn’t the best combination. Something about risks, returns, and not beating the market. And it struck me–do you really need to Beat the Market. The answer is no. And yes. But no.
Really, the answer is–how fast do you NEED your money to grow.
Which led me to think about investments as different forms of transportation.
Imagine you are just starting out after school: lots of loans, no savings, not much salary. It’s a long way from here to retiring to the good life: kicking back, no worries about paying your mortgage, possibly even shopping at Whole Foods and not caring about prices. These two states are very far apart, sort of like Los Angeles and New York City.
If you save your money and keep it in cash, with the currently low interest rates paid paid by the banks (1.7 to 2% if you look around, though most places offer much less), the rate at which your savings grow will be quite slow. Most of your money will come from brute savings, rather than growth due to compound interest. On the other hand, if you have an FDIC-insured back account (or NCUA-insured credit union account), you’ll never lose your principal. Think of this as traveling by walking. According to Google Maps, it would take you 913 hours to walk from NYC to LA, or 114 days at 8 hours a day. What a slog! My feet are tired just thinking about it, and it’s going to be a long trip. Similarly, it will take you a very long time to clear your school debts, pay off your house, and have enough money in the bank that you’ll never need to work again. Possibly it will take more years than you are willing to work, unless you can save a vast amount every year.
You might consider bonds. These may give a 4 to 6% return, and you can be pretty sure (though not 100% sure) that you will get your initial investment back. Think of this as bicycling: sure, you can hit a pothole or lose your balance, but on a bike trail you’ll probably do OK, and you’ll certainly move faster than a pedestrian. A bicycle trip from LA to NYC should take about 256 hours, or 32 days at 8 hours a day. That is still a long time, though perhaps if you start early enough and plan for the time it will take, it will be OK. I think someone investing in bonds might be able to retire to the good life, but they will have to put aside a good amount of money every year.
Maybe you want to retire faster–maybe you are thinking about retiring early. Maybe it took you a while to think about saving for retirement, and you are older. You’ve heard about stocks, you can get an even better return on them–maybe 8, 10, or even 12%! Maybe you’ll pick a couple of great stocks (Netflix! Amazon!) and double your money in a few years. You might consider this like getting into your car and driving. That would cut your trip to 42 hours: a 5 day trip (maybe even 3 or 4 days, if you push it). Of course, you can get into a lot more trouble with a car. If you try to go 110 mph, you might end up off the road altogether, and maybe never going anywhere, ever again.
When it comes to stock investing, a lot of research suggests sticking with the speed limit and staying on the main roads (=investing in a broadly diversified portfolio, using index funds). Your return won’t be as high (probably more like 8%) but you are less likely to crash and burn, losing all your money. Sometimes, there are traffic jams, and you might see bicyclists passing you up in your car. Sometimes the roads are closed, and really the only way to get somewhere is on foot. But, you know that over time, the best way to go a long distance is by motorized vehicle. Investing in stocks is probably the best way to make your savings grow quickly.
Lastly, we could consider flying. I might compare it to building/owning your own business. If things go well, people can make a lot of money, and even get set up for life; when they don’t go well, people can lose their shirts. Similarly airplanes can take you somewhere super fast, except when they don’t. It’s a 6 hour flight coast to coast, maybe 5 with a tail wind. I would point out, though, this doesn’t take into account getting to the airport, parking or getting from the transit stop, checking in, clearing security, walking to the boarding area. And then waiting…. Sort of like you need cash, and maybe bonds and stocks, to smooth your flight.
All of this discussion assumes, of course, that you have a very long trip ahead of you. What if you are further along in your trip? What if you are a 40-something year old professional who has already been saving for retirement and paying down debt? Maybe you are already in Baltimore? A flight to NYC would be nice, but maybe it’s overkill. You could take a train or a car and get there in a few hours. What if you are in Brooklyn and have to get to Central Park where your niece is having her birthday party at the zoo? Maybe you are just 5 years from retirement? You could take the subway, or you could bike, or even walk, depending on whether you have a lazy day, or have plans to meet someone and want to be on time. At some point it’s just better to walk–maybe you are just a few blocks away from the Park entrance (or, you plan to retire in the next 1-3 years). If you get in a car, you might find out the streets are closed for a parade, or you can’t find parking. Get out and walk, you are almost there! You don’t want to circle the block and miss the birthday cake.
So no, you don’t always have to beat the market. You just need to get where you are going, on-time.