Often The Best Thing To Do With Money Is …Nothing
We can spend hours upon hours researching investment opportunities. Days and weeks spent debating, or arguing, on the Internet with strangers as to why investing in real estate is a wiser option than following a stock market investment strategy.
Others will spend years studying financial topics in college, then dedicate their entire working life to the subject.
There are a myriad of options, and opinions, when it comes time to invest.
Many investment strategies can be difficult to understand, but an investor doesn’t need to understand every investment strategy available in order to be successful. An investor only needs to understand the one or two strategies that they are implementing.
But even easier, “doing nothing” is exactly what needs to be done.
About “Doing Nothing”
Here we are talking about the strategies where “being in the market over time” is the most important aspect. Often this will be related to investing in areas such as index funds and established blue-chip stocks and property.
This is the long term “buy and hold” strategy that most Internet commenters claim that they are following, yet most in reality are likely in only the first year or two of the strategy.
For the purpose of this story, “doing nothing” means setting your strategy on the right path and then not touching it.
$1000 invested per month in the stock market at a 7% return over a 40 year working life results in just over $2.6 million. Even slashing those returns to 3.3% would still leave you a millionaire.
These return numbers aren’t anything special, they are roughly what the market has historically returned over time. You don’t need to be Warren Buffett or Ray Dalio to get these returns. But how many people can stay focused on a single strategy over decades and resist touching it?
What usually happens is that we see other opportunities. We see crypto currency investors on social media becoming overnight millionaires, driving around in a Lamborghini (likely rented!), then we look back at our single digit returns and feel inadequate.
We feel as though what we are doing is not enough. We feel as though we should be doing something more. We feel like we need to make a change.
It was Theodore Roosevelt who said “comparison is the thief of joy”, and he wasn’t wrong.
Maybe we are a little more rational than going all-in on crypto and decide to swap from one established “safe” option to another. For example, going from index funds to property.
How does an investment strategy switch impact us over the long term?
Scenario
You have had $250,000 invested over a few years, it is now valued at $500,000. Great work, you’ve got a current capital gain of $250,000 on paper! Now it’s time to decide what you are going to do for the next 30 years.
Option 1: Switch to a different investment strategy
You decide that there is a different investment strategy that you’d like to follow. You sell your $500,000 asset.
At this point you have a realised capital gain of $250,000, on which you must pay tax. Tax rates vary greatly around the world, but in most cases it can be expected to be 20-50% ($50,000 to $125,000).
Next there will be transaction costs, both to sell your first asset and then to buy the second. On the lower end of fees may be a simple sell and buy of shares. If it is property then there are likely agent fees, legal fees, marketing and various government taxes. These costs can vary greatly, but it isn’t unusual for these to be at least 1-2% at each end of the transaction ($5,000 to $10,000 x2).
Add up those costs and you are in the realms of $60,000 to $145,000.
From your initial $500,000, you’re now left with $355,000 to $440,000 to place into your new strategy.
Your new strategy returns 7% over the next 30 years.
At the end of those 30 years you have between $2.88 million and $3.57 million.
Option 2: Do nothing
You are boring. You don’t touch a single thing and leave your money sitting there for the next 30 years.
That initial $500,000 ticks away at 7% over the next 30 years.
At the end of those 30 years you have $4.05 million.
The end results
Making that investment switch cost us between $480,000 and $1.17 million.
Granted, in the initial example we paid capital gains tax on $250,000 of our profit already, so we can take $50,000 to $125,000 off the split.
Sure, the example is simplifying things. Different tax rates, different transaction costs, different options for what you do with the asset at the end. There are also special tax loopholes available in some countries when you are selecting to re-invest profits.
The numbers are still very significant. Compounding over time delivers outstanding results.
But at the very least run the numbers.
Other factors to consider
Different types of assets perform differently over time.
It would be foolish to suggest that you shouldn’t consider that your investment option may not have been the best choice.
And maybe you are even correct that switching from one strategy to another will gain you a couple of extra percentage points per year. But how many percentage points higher must it deliver over the long term in order to bridge that gap of $480,000 to $1.17 million? At least run the numbers.
And this example is only considering a single switch of investment strategy.
Many of us have made one or more switches already, and still have many more years of investing ahead of us. That’s many more years of watching the popularity of different investment strategies rise and fall. Many more years of witnessing overnight millionaires and feeling as though we should be doing more. Many more years of being tempted to make a switch.
In closing
Albert Einstein is quoted as saying “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it”.
Great quote and absolutely accurate. But one thing I like more is to visualise the snowball effect.
The image of the snowball rolling down a mountain; initially only the size of a golf ball, it picks up pace and size as it continues to roll. The golf ball grows to the size of a tennis ball, then a basketball, then a beach ball. Those who can keep their hands away for long enough will one day be at the bottom of the mountain and hear a roar fill the valley, as what was once only the size of a golf ball is now taller than a house.
Once your snowball begins to roll, strongly consider DOING NOTHING. It is often the correct answer.
Easier said than done.
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