1 Simple Strategy To Maximize Wealth (If You Don’t Have The Time To Invest)

Note: This piece is meant for a lay person. Also, this piece is not meant as investment advice.

I was listening to a Tim Ferriss podcast with Tony Robbins the other day and Tony talked about how every percentage point in fees and other expenses can really make a big difference to our investment portfolios, because of the impact of compounding. So say you have a 5% return. If a mutual fund takes a point off that, you will really feel the difference at the end of 30 years. This is a truth about everything in life — our own personal development, technological improvement, etc. Compounding can make a huge difference. For example, 30 linear steps will take you from 0 to 30. But 30 exponential steps will take you to a little more than a billion. Compounding is HUGE.

Before I get into the weeds a little more, it is important to note that this article is a recap of my own analysis for my own investment needs. This analysis is high level and appropriate for my own risk profile. There is lot more to consider such as alternative investments available, risk tolerance, cash needs, etc. and yours may be very different from mine.

I looked into the S&P 500. Over the last 31 years, the S&P has, on average, returned around 12% annually — which is quite impressive considering this includes the great recession and the dot com bust. What’s even more impressive, is that if you had invested money in any of the years between 1988 and 2016, you wouldn’t have lost your initial capital at the end of 2016, even accounting for inflation.

Over the same 31-year period, average inflation was 2.62%. Therefore, real returns (nominal returns minus inflation) were approx. 9.1%. This is quite an impressive return — this basically means that you can double your money, in real terms, about every 11 years.

Granted, this is essentially the market return, so there is no alpha, but 9.1% is nothing to sneer about. This shouldn’t be anybody’s entire portfolio (these returns wouldn’t have materialised at the end of 2008 for example), but given the healthy return, wouldn’t it make sense to invest at least a part of one’s income in a security that closely tracks the S&P? My thinking here is that while there may be safer or higher-yielding asset classes, over the long run and as one piece of a diversified portfolio, this strategy can be very fruitful. What I particularly like about this strategy is that it does not need to be actively managed by the individual (saving time), does not require financial savvy (de-risking things further), and can be relatively inexpensive (because its relatively easy for fund mangers to manage also).

So I did the math. What if I had invested $10,000 in 2016 dollars every year starting 1988 and held on to that investment. How much would it have been worth at the end of 2016? Here is the math (which excludes taxes):

Each column shows how the value of the investment for that year would have changed over time

At the end of 2016, I would have had $880K on an investment of $290K (in 2016 dollars), which is a ~3x return. I think this is a great return, given the relatively low risk of the broad market. $10,000 a year is a manageable amount for many families but the same math works for other contribution amounts as well (every $1,000 a year returns approx. $88K in 2016 dollars).

Granted, it is not always possible to stay invested for ~30 years, and also 1988–2016 seems fairly arbitrary. What about other investment horizons? So I built a data table of all possible investment “in” years and “out” years and calculated inflation adjusted returns (as cumulative returns minus cumulative inflation — this is an important distinction; calculating using annual real returns will lead to vastly different outcomes again due to compounding, but since the goal is to STAY invested, I thought this method made a lot of sense). The results are very interesting.

As can be seen in the table below, if one can stay invested for anything more than a few years, the outcome is almost always positive. The only stretch of time when the cumulative real returns were negative was immediately post the dot com bubble (it took more than a decade to return to profitability). But in every other case, the outcome is pretty good. Even after the Great Recession, the investment would have turned positive very fast and in fact 8 years later the cumulative real return is almost 75%.

Data table of possible returns if one were to invest in the S&P in any given year and take money out in any other given year. The meta point is that in general, returns turn positive in very short order (the dot com bubble being the outlier here).

The key is to dollar cost average and be patient. There is no point trying to time the market. Timing the market is a search for alpha — if you’re a full time analyst of the financial markets, then by all means try to time the market. But most of us aren’t, and I think trying to find alpha when all we can do is devote a few hours a month to this is not only risky it’s downright stupid. I like this approach for one other reason: it reduces decision fatigue. Ideally, I want to set this up once (automatic monthly purchase regardless of price) and then forget about it. In terms of costs, I think it is important to 1) identify a fund that has a low expense ratio and 2) identify a broker that is cheap, no-frills, and gets the job done without a fuss.

I researched this online a little and found that tax was a big concern for many. Tax is indeed something to be cognizant of, but 1) 9.1% is a good return even if it the returns are entirely taxable — remember long term inflation is less than 3% and if inflation rises, so will the markets so I believe there will be some downside protection, and 2) although it is inconvenient to figure out the cost basis for all those trades, it’s not THAT inconvenient. Given all the other benefits I mentioned above, I definitely will make this part of my overall asset portfolio and investment strategy.

Notes:

1. I used a dataset starting 1988, which is right after Black Monday. As a result, the period I considered would naturally lend itself to a very positive outcome. However, as can be seen in the second -data- table, for most combinations of “in” year and “out” year the returns are favorable.
2. In speaking with a couple of folks when writing this piece I thought about whether this same strategy might be applicable to an overall 401K portfolio. The quick answer is “no”. The key reason is that generally speaking, a person’s 401K contributions will rise (hopefully significantly) over time, which will cause the later year contributions to be overweight relative to the earlier years. In such a situation, any later year market crashes will make a portfolio recovery much, much harder.
3. This exercise is essentially the same as investing in index funds. An additional advantage of index funds is that some house funds don’t charge commissions.

Disclosure: I’m not a financial analyst or accredited to provide any financial advise, these are my personal opinions only.

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