One thing that Wall Street wants you to believe is that you have to get your money into the markets today-or you are never going to retire the way you hope to. Why? How else will they get you to buy their investments today?
In reality, you have time. You absolutely have to start saving money today, but you do not need to get it into the markets just because you have it. Let me explain:
For our purposes, let’s assume that a Wall Street mutual fund will grow at 7% on average for the next ten and twenty years-a fair assumption. Let’s also say that a diversified portfolio of dividend-paying stocks will grow at 11%. Finally, let’s say that buying wonderful businesses at a discount to their true value will grow at 15%.
Don’t worry, I’m not going to get technical on you. Let’s just add one more assumption-money markets or savings accounts will pay you 5% a year so long as your money is in cash and not invested in mutual funds or stocks.
In Ten Years
Investing today and growing at 7% a year, $10,000 in the Wall Street mutual fund would grow to $19,672 at the end of ten years. Now the question-when would you have to buy your diversified portfolio of stocks or your wonderful businesses to end up with $19,672 or more after ten years?
The Diversified Basket of Dividend Stocks: If your basket of stocks grew at 11%, you could leave your money in cash, earning interest, for six full years. Then, you could buy your basket of stocks, hold them for another four years, and end up with $20,344 after the full ten years. You would still be ahead of the mutual fund and you would have waited six years for the right opportunity.
Wonderful Businesses, On Sale: What about the idea of owning wonderful businesses at bargain prices? How about sitting on cash for more than seven years? If you did nothing with your cash for more than seven years, then bought a wonderful business that grew 15% a year for the next two (and a few months), you would still end up with $21,400-more than both other situations.
That Difference Is Real, Tangible
Take that same situation and stretch it out over thirty years, and you have some gigantic differences. Your mutual funds would be worth $76,123. A diversified basket of stocks would be worth $164,016. Wonderful businesses? Try $350,248.
Cute. But $350,000 Won’t Fund My Retirement
That’s right. And that is exactly why you need to start saving today-even if you can’t find an opportunity to buy a wonderful business for the next seven years. You need to start socking away the cash now so that you can pounce on an opportunity when it presents itself.
Of course, it shouldn’t take you seven years to find a wonderful business selling at a discount. The markets tend to move in 3- and 4-year cycles. That means that they tend to go from overpriced to underpriced every three or four years – and everywhere in between. That also means that you will find yourself with one or two great opportunities every two or three years.
Let’s Look At A Scenario
Let’s say you don’t have anything saved up right now. Maybe you have a 401k or a brokerage account, but I’m going to play the devil’s advocate for everyone out there. If you do have savings, the following example simply compounds.
Okay. So you have nothing saved up. But, you can start putting $150 a month into a brokerage account paying 5% interest. In addition, you can increase your savings by 5% every year. Finally, it takes you two years to find one perfect opportunity. The rest of the time, you are simply enjoying life-ignoring the daily silliness of the stock markets.
So you start saving today. Nothing happens for two years-but you earn some interest. Then, opportunity knocks. You find a wonderful business at a discount. You have $3,901 in your money market so you round it to the nearest hundred and buy $3,900 of your wonderful company.
Two years later, you do it again-this time with the $4,300 you have in savings. I’ll spare you the play-by-play-after 30 years, you are sitting on $1.3 million and some 15 wonderful businesses. Ten years after that (and probably well into your retirement by then), you’d have more than $6 million.
All with very little work, very little risk, and not a whole lot of money. How much better can it get?
But I Don’t Have 30 Years To Save!
Maybe not. Though you likely have 30 years or more to invest (you’ll need your investments to grow straight through your retirement), you may not have 30 years to invest. The only thing that changes is that you have to save more each month.
If you did the exact same thing as above, waiting for that perfect opportunity and then concentrating your cash into it, but started by saving $500 a month, you’d have about $2 million in 25 years. At $1,000 a month, you’d have $1.8 million in 20 years-and $8.8 million by year 30!
I Need More…Sooner
The reality is that it probably isn’t going to happen. You need to work with what you’ve got. If you’ve been so burned by Wall Street’s “advice” that you are now behind the 8-ball, you have to play catch-up…without gambling.
You have two choices-gamble more and hope you can beat the professionals, or save more. One thing I would recommend is to take control of your 401k. Your 401k plan is likely your largest savings account. If you can buy wonderful businesses in it, do it! If not, talk to your plan administrator about being able to add that feature or add a “Separate Account” feature.
Going Full Circle
Where will that 7% mutual fund get you in 30 years-even if you are investing $150 a month and increasing it 5% a year? $317,724-nearly $1 million less than you should have had. But hey, you were diversified.
Filed under: How to Think About Investing
Sage,
Great question. Whether buying an entire business or part of a business (through stocks), the principals are the same.
When you invest in stocks, you should invest as if you are buying the entire business and your future depended entirely on that one business. When you look at investing like that, it puts the stock market in a whole new light.
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Great article and I totally agree with you. Thanks.
Henrik Soke,
http://www.activeinvestorsblog.com/
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So, let’s say that I choose to invest in wonderful businesses at a bargain, waiting 7+ years to find a suitable company for my investment money. You say for those 7 years where I have not chosen a suitable company, I should be in a money market earning ~5% annually. Why would you not recommend investing that money in a S&P500 index fund or something similar. If we are waiting such a long time to invest that money and it is really there for the long term, wouldn’t it be better to be invested in equities, theoretically earning 10% on our money until we find that 15% per year investment?
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Ryan,
Think of investing in terms of risk-reward – The reason Joe uses a discount rate of 15% is becuase that is the returns he seeks but he also gives himself a MOS of 25%+. This is for the risk premium (I am getting to the point).
Let say you have identified a powerhouse company that you know will give you the return you seek. But its priced either at or above your calculated IV and you are not getting your required MOS. Also there are no other companies that you can invest to get your return.
What you do (and Warren) does is wait patiently for the market to hand it to you. Of course you do not want your cash sitting aorund and not earning anything, so you find a short term vehicle (high savings account etc) that is safe and will provide reasonable return.
Remember the market is unpredicateble. What happens if the market gives u an opportunity to invest in the wonderful business and your cash (ex:5000) is sitting in an index fund waiting for deployment. One of the reasons that you are getting this opportunity (to invest in this great company) maybe is that the markets are down hence the index fund is down. Your original saving of 5000 is now worth less hence you are not able to invest the whole amt. You may get lucky and the markets are up and you now have more than 5000.
Question is do you want to risk it?
Sorry for getting kinda long winded.
If you are waiting to swing big, do not loose the bat (Warren & Munger say it bettter).
Giggsy
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But theoretically if we are waiting multiple years to invest that money into an individual stock, that $5000 should have grown a bit by the time you spot a stock. So if the market goes up at its expected rate for 2 years before I find a good stock, my 5k should be a little over 6k now. I understand what you are saying, but I am looking at in terms of maximizing my Expected Value. If at any random point in time, the S&P has a higher expectation than cash, would it not make sense to stay 100% in stocks? I think your point is valid if you are looking to pick up stocks when the entire market is down (When a good stock goes down considerably, is it usually because of macro factors or because of bad news/quarters/earnings etc.?) I think if one really is super patient to wait for dynamite stocks that may only come around every few years, it would be better to have that 5k in stocks. But if you are buying new stocks once a year or sooner, it’s probably better to keep the money in cash.
By the way, I’m not trying to challenge the knowledge of Joe or you, Giggsy. I’m really just thinking out loud and trying to get a handle on all of this stuff before I take the plunge into equity investing. So feel free to tell me I’m wrong…my feeling won’t be hurt.
-Ryan
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Ryan: If you knew that you would be waiting seven years before you found an opportunity, you would definitely be wise to put your money to work elsewhere. But, we don’t know if an opportunity is going to come tomorrow or a year from now.
When investing in the S&P 500 (or other market), you are subjecting your cash to the daily volatility of the markets and the annual swings driven by fear and greed. That sounds great when the markets are rising, but terrible when they are falling.
Imagine that your perfect opportunity comes along – and you have 5% less cash to invest because you decided to invest in the markets while you waited. Let’s further assume that it took two years for the price to reach the intrinsic value, and that you would sell at 90% of intrinsic value.
After two years, you would have 5% less money than if you had not played the market game and instead waited in cash or other secure, interest-bearing, “safe” vehicles.
If you know that you won’t be putting cash to work in individual companies for a few years, you can consider putting that money in an index fund. Still, if you are going to risk it at all in the market, and if you eventually want to own individual companies, why put it to work in the index fund?
Food for thought.
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Interesting but I’m not sure I follow exactly what you are saying. When you say “…buying wonderful businesses at a discount to their true value will grow at 15%” in the first paragraph, do you mean actually purchasing a business (a costly endeavor) or do you mean investing in stock market business?
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