A Young Investor Willing to Take Moderate Risk Can Make How Much!?
I've got good news for you - if you're a young investor willing to take moderate risk you could be doubling your money in just over 7 years. So how can you double your money every 7-8 years without taking on excessive risk? It has to do with how we look at risk.
What is Risk
Most investors wrongly think of risk as the tendency for their investments to fluctuate in net asset value or price. Changes in the market price of your investment happen day to day and even every minute. This is known as volatility risk and it is simply one of many kinds of investment risk.
Another type of risk known as purchasing power risk will erode the value of your money over time by not investing in the stock market. Over time inflation steadily increases the price of a basket of goods while your $10 in your wallet remains the same. You slowly lose the ability to buy things with that $10.
Other types of risk include:
- Market Risk
- Timing Risk
- Systemic Risk
- Political Risk
- Interest Rate Risk
- Sector Risk
- Asset Class Risk
How To Take Smart Risks
Once we understand the different types of risk, it's much easier to figure out how "risky" our particular style of investing may be. One person may see bond investing as "safe" while another sees it as "risky" and both people could be 100% correct.
It depends on why you're making those investments, what your strategy is, and how you've positioned yourself in the move.
Historically stocks have outperformed bonds on a total return basis over time. Young investors might find it risky to invest in bonds due to the long term risk of that asset classes underperforming equities.
Another investor might see a total investment in equities as risky due to the high historical volatility, or price swings, involved with stock investing.
Each of these viewpoints holds value.
Going All-In On Stocks
For the young investor who understands the overall big picture of market dynamics and risk as it applies to a holistic view of investing, I will argue that a 100% stock position is only moderately risky. With a 20-30+ year horizon to retirement, a total stock position in investing is not unduly risky for the young investor. I personally use this position.
Taking a 100% stocks based approach to investing (or mutual funds / ETFs) is a smart risk for the 20 or 30-year-old investor willing to understand and tolerate the fluctuations of the equities market in the short term.
In order to make your position in stocks a "smart risk," you will need to understand the pros and cons of your chosen investment. Understand that investing in this way can be difficult and at times when the market turns downward, the pressure to sell can become immense.
I consider this a reasonable approach if:
- You are able to intelligently navigate market downturns by holding, buying, or other strategies.
- You fully understand your asset classes, sectors, and chosen stocks or funds.
- You have a backup plan in place for possible emergencies or contingencies.
- There is absolutely zero chance you'll need to draw on your money in case the market turns sour. This includes having a cash emergency fund and little or no debt liabilities.
- You properly manage the risk of any leveraged positions you may take in the market.
- You're prepared to switch from 100% equities to a more balanced portfolio at a certain point when your life merits the change.
- You have an extremely long time frame to retirement or other investing goals.
How Much Can I Make By Going All-In?
Different sources will cite wildly varying rates of return for the US stock market over a historical window. Most will average the return of the market at about 10% per year. Let me break it down for you with a graph and a few sources.
Average Annual Return of S&P 500
yCharts pegs the annual return of the S&P 500 at 11.74% here.
NYU pegs the annual return of the S&P 500 at 11.42% here.
An author at Seeking Alpha pegs the return at 11.41% here.
Money Chimp talks more about the different ways to calculate the average return here.
CNBC comes in at 9.8% but they've averaged it over a shorter time period here.
Investment Growth By Year
With an average annual market return of 11.018% between the five sources we've listed, we'll assume that's a reasonable historical average. Many would say this is too high, but we're going to work with it since they're the numbers we have. If you're concerned about it, you can run the same math with a lower annual return - say 8% or 10%.
If you take a look at the chart below you'll see that even at an assumed annual return of just 8% annual, the investor above would retire with over $2,000,000 in non-inflation-adjusted dollars.
Funds at Age 65 For Different Assumed Rates of Return
By doing nothing more than maxing out a Roth IRA at today's IRS contribution limit of $5,500 until retirement, a young investor willing to take moderate risk can make over $6,000,000 by retirement.
Of course, the intelligent investor would begin shifting to a more balanced portfolio perhaps somewhere around age 50 which would change the projection of these numbers. However, it wouldn't change them by that much. Since there are so many unpredictable elements of doing this math, it seems whimsical to me to speculate over that in particular.
Remember, you must make your own decisions about how to invest your money. I haven't considered your needs or your risk tolerance. This is simply an analysis of the potential returns for a young investor willing to take moderate risk. There are many assumptions inherent to any projection of investment returns. None of this is a guarantee of performance.
However, to the discerning individual, there is perhaps some worthwhile thought provoking information here.
Would you be willing to go all-in on this type of investment strategy? Let me know in the comments.