The Secret Ingredient
When it comes to investing, people spend a lot of time talking about investment returns, asset allocation, stocks, bonds, ETFs, active investing, passive investing, etc. etc. But is there a secret ingredient? One magic element that drives investment success? It turns it, there is!
I don’t want to sound like the president of the Morgan Housel Fan Club, but I read a lot of the stuff he writes and for some reason it resonates with me and thus I want to interpret it and share it with you. In his December 17, 2020 blog, https://www.collaborativefund.com/blog/, Morgan wrote a piece called, “Last Man Standing”. In it he says, “Everything worthwhile in investing comes from compounding. Compounding is the whole secret sauce, the rocket fuel that creates fortunes. And compounding is just returns leveraged with time”. This is the reason that 97% of Warren Buffett’s net worth came after his 50th birthday and 99% came after he turned 65. Sure, Warren Buffett is a great investor, but the secret to his astounding net worth is compounding of returns over a long period of time. I’m pretty sure that Warren Buffett has a quote stating that compound interest is the 8th wonder of the world. So how does this apply to you?
There was a jazz trumpet player named Dizzy Gillespie. Perhaps you have seen pictures of him. When he played the trumpet, his cheeks puffed out really far. All of the images I have seen of him playing are copyrighted, but you should go look up his picture if you don’t know who I’m talking about. Anyway, somebody asked Dizzy why he puffed his cheeks out when he played and he told them, “You blows how you blows”. So what does Dizzy Gillespie have to do with compound interest? I’m glad you asked.
In Morgan’s piece he says the key to investing isn’t how can I earn the best returns, rather, it is what are the best returns I can sustain for the longest period of time? This is where Dizzy comes in. One of the keys to you being able to sustain returns is knowing how much volatility you can handle. In English, that means, how much could the value of your investment go down before you freaked out and interrupted your compound interest. You need to know how you blows. It doesn’t matter how old you are, or what your neighbor does or what you read in a stupid blog post. To me, risk tolerance is all about how much you could handle your portfolio dropping before you bailed. If you can be honest with yourself and your advisor, it makes it much easier to design something that fits you and your situation.
This gets particularly important when the value of your portfolio increases. It’s not about the percentages, it is about the dollar amount. I had an appointment with a doctor one time and he told me his 401k had dropped $75,000. As a percentage of the total, it wasn’t that big of a deal, but I told him it was freaking him out because the dollar amount was twice as much as he used to make as a resident physician. Luckily he didn’t bail out and his account did increase in value.
I remember reading something that Warren Buffett said. He said the reason the majority of people’s net worth was in the value of their home was their home values weren’t published in the paper every day. In today’s world, your phone is telling you how much the stock market went up or down, every minute, much less every day. There is the entire financial pornography industry. Magazines and websites telling you the hot stock to buy now. Television programs talking about how many houses Elon Musk owns. Articles about the one dude who bought Tesla when it is was $10.00 per share and now he’s retired at age 35. Who Cares???
Figure out what you want and when you want it. Figure out how much it is going to take to get what you want. Then figure out how much down you can handle in your portfolio at any given time. From there you can figure out an asset allocation that fits you, not me or God forbid, your neighbor. Finally add the secret ingredient, compounding!
The Secret Ingredient
There you go. The secret to investment success is compound interest and Dizzy Gillespie! You’re welcome! If you want to talk about your situation, feel free to reach out to me. You can schedule a phone call by clicking the Get in Touch button at the top of my website. Have an awesome week and thanks for reading! KB