3 min read
In my early years of college I had about $3,000 invested in three individual stocks.
I checked the prices of this little basket of assets every day, several times per day. I thought I was being a prudent investor, but I failed to see that I didn’t have enough money invested for investment returns to have a major impact on my finances.
For example, suppose my collection of stocks increased in price by 7% over the course of the year. That would be an increase of ($3,000 * .07) $210. If I wanted to lock in those gains, I would have to pay the $7 trading fee to sell each individual stock, which would drop my total gain down to $189.
(I wouldn’t have had to pay the long-term capital gains tax since my yearly income at the time was less than $37,950)
In the grand scheme of things, $189 is peanuts. I would have been better off finding a $20 cheaper monthly phone plan to save $240 over the course of a year.
My focus was in the wrong place. I was thinking about how sweet it would be to earn a 7% return, instead of the actual dollar return. I didn’t realize that investing was about absolute numbers, not percentages.
Running the Numbers
Let’s run some numbers on the S&P 500 annual returns since 1950 to find out just how important absolute returns are compared to percentage returns.
During the best ten-year stretch (1950 – 1959), the S&P 500 delivered 19.5% compounded annual returns. Conversely, the worst ten-year stretch (1999 – 2008) delivered -1.4% compounded annual returns:
Consider an investor who lucked out and caught the 1950 – 1959 gift from the investment gods, but only invested $5,000 each year in the S&P 500. At the end of 10 years, they would have accumulated about $140k:
Now consider an investor who got dealt the worst 10-year investment hand ever from 1999 to 2008. To attain the same $140k as the previous investor, they would have needed to invest $17,000 each year:
This is incredible to me. Someone who invested $17,000 each year during the worst decade of investment returns since 1950 could have accumulated the same amount as someone who invested $5,000 each year during the best decade of returns:
In dollar terms, each investor would have ended up with the same amount. The only difference would have been in how the investors felt about their performance. The 1950 – 1959 investor would have been ecstatic, while the 1999 – 2008 investor would have felt devastated.
And while the percentage investment returns would have been wildly different for these two investors, the absolute dollar returns would have been the exact same, which is all that actually matters.
We can perform this same thought experiment with 20-year investment periods, too. The best 20-year stretch since 1950 delivered 17.7% annual returns (1980 – 1999) while the worst 20-year stretch (1959 – 1978) delivered 6.5% annual returns:
Again consider someone who invested $5,000 each year during the best 20-year period. At the end of 20 years they would have accumulated $888,000. It turns out that someone who invested during the worst 20-year period would have needed to invest about $23,900 each year to also attain $888,000:
When thinking about investment returns, it’s easy to get caught up in the percentage returns while ignoring the absolute dollar returns. It’s important to remember that absolute dollar returns are what truly matter.
No matter what type of returns the market delivers in the coming decades, keep in mind that the dollar amount of money you invest is a stronger predictor of financial success than the percentage returns you earn.
Zach is the author behind Four Pillar Freedom, a blog that teaches you how to build wealth and gain freedom in life.
Zach's favorite free financial tool he's been using since 2015 to manage his net worth is Personal Capital. Each month he uses their free Investment Checkup tool and Retirement Planner to track his investments and ensure that he's on the fast track to financial freedom.
Although the bulk of his net worth is invested in index funds, his favorite place to invest in individual stocks is M1 Finance, a site that allows you to build a custom portfolio of stocks for free.
His favorite way to save money each month on his recurring bills is by using Trim, a free financial app that negotiates lower cable, internet, and phone bills with any provider on your behalf.
His favorite place to find new personal finance articles to read is Collecting Wisdom, a site that collects the best personal finance articles floating around the web on a daily basis.
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