Ever heard someone brag about how much they made off their amazing investment? Or talk about how they got in somewhere early and made a killing because they gambled on an unknown company before it blew up?
People often talk about great investments they’ve made or the incredible investment return they’ve received.
But this is, in part, an effect of survivorship bias. What you probably don’t hear about are the other 9 times that same person gambled and lost.
This is just one of the reasons it’s dangerous to take someone else’s random anecdote as a tip for you to try and copy yourself. You need to be careful before you leap into an investment based on hearsay (or simply what you overheard in the office breakroom or at your neighbor’s kid’s birthday party).
If you want to invest, you need a solid, rational strategy backed by a sound philosophy — and a lot of good research and facts.
Investments Are Important, But Don’t Put the Cart Before the Horse
The fact is, making good investment decisions is an important part of growing your wealth over time.
By intelligently putting your money at just enough risk to earn the return you need to meet your goals and account for the needs and demands of the lifestyle you want to afford, you have the opportunity to outpace inflation and increase your wealth.
That’s one of the biggest reasons you need to save and invest — or said another way, why it’s not enough to just save a bunch of cash.
Investing allows you to generate a bigger return than cash savings vehicles provide. The best savings account interest rates (as of early 2019) run at about 2%, or maybe 2.2%.
Meanwhile, inflation is about 2-3% per year — and that’s what will erode your purchasing power over time. Cash that you save today and keep in cash will be worth far less in 20 to 30 years than it is today.
Investing helps beat that problem, as following a smart strategy here and staying in the market for the long-term can help you earn, conservatively, about 5-7% on your money (and more aggressive estimates/investments will hopefully earn you even more).
But all of this is a moot point if you don’t save at all right now… or if you’re not investing because you’re obsessing over what kind of return you can get.
“Saving money” and “investing money” are not the same things — and if you’re not saving anything, then worrying about what return you can get in the market is putting your focus on the wrong thing.
First, Let’s Get Clear: Saving and Investing Are Not the Same
The act of saving is different than the act of investing.
Saving simply means setting aside money that will be used later on. Investing means choosing to put your money at risk for the opportunity to generate a return on your investment (or ROI).
With investing comes the risk of loss. That can be scary, especially for someone who doesn’t understand how much to invest or what to invest in. It may feel like there’s no room for error, because if you get it wrong you risk losing your money.
A couple of things tend to happen at this point for people who feel this way:
- They squirrel away their money in cash and refuse to invest because they’re afraid of losing everything.
- They don’t even bother saving because they say investing is too overwhelming and confusing. They claim that they don’t know what they’re doing… and then use that as an excuse to spend instead of saving or investing.
Instead of doing the wrong thing, they just do no thing. That can be even more detrimental than trying something and making a mistake!
This is also known as analysis paralysis, or the state of over-analyzing or over-thinking a situation to the point that you never make a decision/take action.
And again, doing nothing is often worse than getting it “wrong.”
Taking No Action Yields No Results
Here’s the deal: positive or negative investment returns don’t matter much if you don’t have money saved to invest.
A 7% return on $0 is going to be $0. A 20% return on $0 is going to be… you guessed it: $0.
And even when you get above $0, investment return doesn’t matter as much as you probably think it does. What’s more important are your own contributions rather than what that money is earning.
Here’s an example to illustrate this — because I know it sounds weird to say “investment returns don’t matter.” They do, but probably not in the way you think they do.
So let’s say you invest $10,000 on January 1. You then receive a 7% return on that money over the next 12 months.
Good for you! You now have $10,700 in your account. You saved $10,000 and you earned $700.
Notice that most of the increase in the account over the year came from you saving $10,000. The $700 is only a small portion.
In other words, your investment return, although nice to have, didn’t really impact your account all that much.
Now, let’s say you’ve done a great job saving over a long period of time. You have $1,000,000 to invest. Again, you invest that money on January 1 and you earn 7% over the next 12 months.
By the end of the year you have $1,070,000 in your account. The investment return was $70,000.
The takeaway? Your return creates a much bigger impact when you’re working with bigger balances.
Obsessing over your rate of return when you haven’t even started investing, or letting that be the thing that stops you from investing (because you’re waiting for the promise of an optimal return) makes no sense and is only stopping you from using your real advantage in investing right now: time.
The returns don’t matter as much early on, when you’re getting started. Don’t worry about them to the point that that’s your reason for not investing… or worse, your reason for not bothering with saving at all.
The best way to financial success? The answer to that is always simply get started.