Principles of Wealth #29*
There are proven ways to safely achieve a higher-than-average ROI for certain asset classes under certain conditions. One can, for example, safely double the ROIs on income-producing real estate by using bank financing wisely. The same is true for many business transactions, some stock strategies, and a handful of other asset classes.
There is a perfectly understandable reason why investors care so much about ROI (the rate of return they get on their invested money). Consider the difference between making 10% versus 20% on a grubstake of $20,000 over 40 years. At 10%, you would end up with $905,000. At 20%, you’d have $29 million!
Here’s the problem: It’s basically impossible to get a 20% ROI over 40 years. When individual investors try to get those sorts of returns, their actual average ROIs are less than 3%.
So the real difference isn’t between $905,000 and $29 million. It’s between $905,000 and $65,000.
Nine hundred grand is not a fortune, but it’s a heck of a lot better than $65,000.
Sixty-five grand will get you just about nothing. Nine hundred grand will give you a theoretical return of about $90,000 a year. Most financial planners agree that taking out 4% every year is safe. Four percent of $905,000 is $36,000. That’s how much you could take out without depleting the base.
This brings us to a related principle…
Although it’s foolish to try to double the natural (historical) ROI for any market, there are reasonable ways to achieve modestly higher gains safely.
There are ways in almost every market to outpace the averages by, say, 20% safely. For example, if the average ROI is 10% (as allowed for above), it is sometimes perfectly reasonable to shoot for 12%.
The difference between 10% and 12% may sound like very little. The math may surprise you.
That same $20,000 invested over 40 years at 12% will effectively double the end result, taking the retirement nest egg from $905,000 to more than $1.8 million. Four percent of $1.8 million gives you $72,000 a year. A big difference!
If you try to turn that $20,000 into $29 million, you will likely end up with $65,000. Which will be worth, after inflation, no more than you started out with.
If you are happy to get a historical market return of 10%, you’ll end up with $905,000 in your retirement account, from which you can take $36,000 a year.
If you tweak your investment strategy to get just 20% more than the average – in this case, 12% – you will end up with a retirement nest egg of $1.8 million and the ability to withdraw $72,000 a year safely.
* In this series of essays, I’m trying to make a book about wealth building that is based on the discoveries and observations I’ve made over the years: What wealth is, what it’s not, how it can be acquired, and how it is usually lost.