As we consider how to build wealth like an ant, we’ve covered a couple of topics thus far. First, we discussed the imperative to work while it’s summer. That means that almost every one of us who sets out to build wealth will need to put our nose to the grindstone and work for a season, during which we’ll acquire skills and resources. For most of us, it means we’ll find an employer and earn a salary, at least for a while. This is just as true of an aspiring plumber as it is of a wannabe CEO.
Next, we discussed the importance of managing that earned income. We called it Storing Provisions in Autumn. Because of the magic of compounding interest, the combination of earning more than you need to live on and saving your extra in a vehicle that will produce returns leads to inevitable wealth. That wealth can be your fuel for future ventures, or it can be the wealth that your family uses to fund other components of your family vision.
Then we gave you a bit of a warning for those wonderful seasons of earning and saving. It’s the simple but oh so powerful caution against Worshipping Your Job! If you think your title makes you an important person… or you’re stressed, under-slept, and uninteresting… you might have Job Worship Syndrome. This is a very important skill to stay connected to, lest you smart, gifted workers impress your bosses a bit too much then, because of The Deal (you’ll have to read the article to know what that means), they start to pull your identity into your employment. No, my friends. That is not our look.
This week we continue this (Incredible! Inspiring! Practical!) series with a highly tactical look at how the “boring” investment vehicles of stocks and bonds (*yawn*) can work to your advantage. While I’m a big fan of things like new businesses (wow!) and real estate (oo-ee!), today I’m going to talk about the stuff that scrolls across the CNBC ticker when you’re in line at the bank. Stocks and bonds, my boys! These things can be a powerful piece of the puzzle for the construction of long term wealth! (No, I’m not kidding.)
At this point, you’re either:
- Rolling your eyes, so frustrated that your WHIZ BANG GENIUS favorite outpost-building blog is selling out to talk about something so boring and worldly as the stock market, or you’re
- Licking your chops, ready for the Hot Stock Tip that’s going to earn a 4000% return as soon as we blast out of the currently depressed market that has been brought on by viruses and unemployment! “Oh boy,” you’re instinctively musing, “An analyst’s read on ye market! Bulls! Bears! Hedges! Straddles! BUY BUY!” Whoa, settle down buster. Or you might just be:
- Reading because you assume it’s good for you. Ok, fair enough.
Someday we’ll do a whole article about why stock-picking is a fool’s game, but for now let me just give you a couple of thoughts about why we at Abraham’s Wallet do not endorse any strategy that aims to “beat the market”:
- First, it’s become super easy to own the entire market by using index or mutual funds to hold tiny pieces of almost all of the securities that are traded. This is so sweet!, because, on average, 87% of all individual stocks are outperformed by an index capturing the performance of the overall stock market each year.
- Based on that stat, you can either hope and try to guess which stocks (that you’re aware of–which is a teeny tiny fragment of the market) are going to be a part of the 13% that beat the market… or just invest in the overall market.
[The bond market is a bit harder to characterize in this way, but it’s safe to say that you can usually achieve your fixed-income goals very inexpensively by investing in similar broad indices instead of paying hefty fees to some nerd who may or may not beat a comparable index fund.]
- Even if it’s possible to beat the market (and it isn’t; not repeatedly for years), you’re prooooobably not the guy who is going to do it. Did you know that there is substantial evidence suggesting that, by doing exactly the opposite of what retail investors do (er… that’s you, chuckles), fund managers and institutional investors can make lots and lots of money? This is because, as much as you may want to believe otherwise, the information about all of the stocks and bonds in the world is generally already priced into the stock by the time you get a shot at purchasing it.
- Because institutional money managers are slinging around billions of dollars, they can profit from miniscule information edges that may only move prices by a penny or two… whereas, for most of us, the cost of the trade would make that a bad deal even if we got it right. Who wants to pay ten bucks to buy a stock because you KNOW it’s going up two cents? Not us. If you need more convincing, go study up on efficient market hypothesis – we aren’t alone in our convictions here.
- Conclusion: don’t do stock picking. It’s dumb and you’ll lose.
“Ok AW, I can see that owning broad swaths of the market for stocks and bonds is a better bet than picking individual securities, but you still haven’t convinced us that stocks and bonds are even important to own in the first place! My Uncle Romulus made all his money starting a landscaping business!”
Great question Remus: why are stocks and bonds worth owning for a multi-generationally minded family man? Let me take a crack at convincing you of the ways in which these ‘boring’ assets can actually power and support all of your other wealth building efforts. Shall I??
Okay then.
Historically, a balanced portfolio of 70% stocks and 30% bonds has returned an annual average of just under 10% since 1926. (This is an amazing stat I just gave you. It should change your life if you like growing money… which I hear you should be doing.) That means that even including periods such as The Great Depression, stocks and bonds have been a pretty dang good investment for the long run. Of course, there have been 12-month periods in which these investments have not fared so well: Between March 2008 and February 2009, stocks lost 60% of their value in the US. Yeesh. So watch this conclusion, because it’s an important one:
Stocks and, to a lesser extent, bonds
make a terrible short-term investment
but a totally solid long-term investment.
Additionally, unlike the aforementioned small businesses and rental homes, stocks and bonds do not require your daily labor and intervention to do their thing. (Commence with hallelujahs, ye who have dabbled in landlording as I have, with little to show for it!) While smart asset allocation and investment management can substantially increase your returns (even when you’re using an own-the-whole-market strategy… but more on that in a future article), you’re not responsible for the daily operations of the companies that you own, so stocks and bonds can grow your money while you invest your time and labor elsewhere. You’re basically lending your money to companies, helping them do work, trusting that good ‘ol ingenuity and diligence on their part will bring home an increase on your part. Yays all around!
By way of example, I began building a small portfolio of stocks and bonds in high school. While I never made a killing, I used summers and breaks to work and earn money and, since there are only so many subwoofers that you can fit into a 1995 Chevy Blazer… I had some leftover coin. My father had been very intentional about communicating to me that if I invested a little bit now, I’d have a shockingly large pile of money later, so long as I left it alone. By the time I was 18 I had managed to put about $10k into an account (nice wad, right!?), and though I was still skeptical (and greedy. Let’s admit it: our desire to have big money quick is about greed), I played along and mostly forgot about this money for years…
Let’s say I wanted to tap into that high school wealth now, and that it’s grown by 10% (for the sake of easy math) for the past 20 years… (Are you excited for me? I am. Wanna see my cash stack? Okay…)
Well I would have more than $67,000 to work with. Sixty seven grand!
- Could you survive for a year on $67k while you labored to get a new business started?
- Could $67k be a solid downpayment on an asset that would produce income for your family for the next 4 generations? Or, if you love your 9-5 gig,
- Could you leave that 67k in place and let it grow until you’re 68 years old and have well over a million bucks to fund your needs in retirement?
YES!!! on all counts. And this, my hombres, is why stocks and bonds are important to almost every person’s financial picture – especially when you get started early (remember part 2?).
I’m wrapping up. Here’s the point:
These “boring” investments actually form a fantastic foundation for future investments, because they give a high degree of flexibility to their owner!
So if you think that someday you’d like to, oh I dunno… have a run at starting businesses, accumulating family assets, even pursuing generosity that far exceeds your current dreams, then uh… you should be putting a portion of your earnings into good old (boring?) stocks and bonds.
A caveat: This is not an article about the nitty gritty details of asset allocation or expected investment returns. I’d love to cover those topics at some point if you guys have an appetite for some first-order nerdery… but today isn’t the day. I’m using very simple numbers and ideas on purpose.
BUT in the next (and final) exciting episode of this series, we’ll go one step further on this topic and discuss HOW to invest in stocks and bonds through common tools like your employer’s 401(k) plan or an Individual Retirement Account. Oh boy!
Until then – keep on working and saving, so that you may build wealth like the ant!
*Mark Parrett is one of the founders of Abraham’s Wallet. When not blogging for you here, he’s raising a family in Salt Lake City, UT and working as a financial planner at Outpost Advisors.
