Consistency & the Law of Averages

 

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I have been getting a great deal of push back over investment strategies, over what the best way and how to invest money is. While I dont claim to know any ins and outs of buying the dips or worse betting against companies, nor do I have success at buying on the cheap and selling high as a day trader. I just don’t have that skill. Although at times I wish I did.

The arguments are stemming from building and making wealth. How to do it and the reasons for the differences. The best answer I can give stems from the law of averages. Your average Joe/Jane may understand the concepts of buying low and selling high, but doing it, are two very different things. Your average Joe/Jane may read the how to day trade dummy books, and likely are not any better for it. Your average Joe/Jane will lose more times then they gain, often depleting any gains or even possibly placing them in the red. Your average Joe/Jane may buy “classes” or buy into millionaire traders groups and likely just end up with what is known as a stupid tax. Honestly, if people were making millions upon millions, do you really believe they would be ‘teaching’ people!?  You will never get something for nothing. But let’s say you are more than capable, to choose the best stocks that are going to be long term performers. In a wealth article written this year by  Nick Maggiulli if you were able to buy the best lows of all time, you still would only have a 30% chance of beating the consistent average investor. He also goes on to show that if you miss the lowest of the lows by as little as two months, only two months; your 30% chance drops to just 3%.

Let’s take this on a different perspective. Let’s say, that you get a small windfall of $10,000 and lets just assume an average return of the market at 10% (buy S&P Index) and let’s assume your 20 years old. You place it into a retirement account until you reach 65 years of age. You will have $876,240. Not a bad return. Of course, it is a long period of time which is what makes the difference with compounding. Now the average 20 year old won’t put away $10,000. That money is going to burn a hole in their pocket faster than a bad burrito shoots from your colon. But hey, this is just an example.

Now, what if we looked at a consistent investor, who buys in all markets, up or down, doesn’t matter. The highs the lows and keeps putting their investment into the index fund. Let’s say from age 20 to age 65 as our example before. And they only put in $100 per month. That it. That’s a cup of coffee per day at Starbucks. Based on the same 10% average return, the Joe/Jane would have ended up with $1,048,150. ?yes they would have invest more of their own money over a very long period of time, however, their chances of a better return more than doubled during the down years whereas if the first investor gambled on only a few stocks could have lost a great deal of money.

Don’t get me wrong, investing from a lump sum is a great way to leave a legacy for children and grandchildren. See our earlier post on leaving a legacy. But for the average Joe/Jane, it’s better to start early and contribute small amounts over a long span of time.  Build wealth consistently over a long period of time is far more advantageous than gambling with stock picks. Even those that say they know, have no clue.

One thought on “Consistency & the Law of Averages”

  1. I’ve had one or two goes at trying to trade one asset for another, but just found it too stressful. As the old saying goes, the market can stay irrational longer than you can stay solvent. Thus, I simply stick to consistent contributions and count on compounding to magnify the gains over many years. A decade later, I have financial freedom! Consistency is my personal superpower 🙂

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