Is it possible to make 20% per year by passive investing? Simple answer, Yes! but not for very long. Some people think it is possible, but there are people who think other delusional thoughts too.
Let’s suppose there is such a magic investment. What will happen?
The mechanics are these.
- Let’s suppose that a long time is 50 years
- Let us suppose that the investment is untaxed ever.
- Let us begin with $5,000.
- 20% per annum is about 4.66% per quarter or about 1.53% per month.
- Money doubles in roughly the number of years that result when you divide 72 by the rate of return. So for 20% about every 3.6 years.
The value in 50 years is $45,502,000. Rather nice. I think I will take two.
Here in the real world, there are barriers to this achievement.
There are no passive investments that can make that rate of return for a long time. There are some businesses that can, but the investment there is far more than merely money. It includes time, skill, relationships, leadership and many other factors. Even those businesses peak, and probably well before 50 years passes. Even if such a situation existed, would someone insert their special skills, risk and effort into a business that might make that amount and then let you, an investor of only money, have it. Original capital is not the most significant variable when it comes to making money.
But let us suppose that magic works in your favour. There is such an investment. Would you get the payoff at $45 million? Probably not.
People are linear thinkers and they are impatient. They do not intuitively understand compounding growth and that creates a problem. $45 million in 50 years does not imply that you gain one fiftieth of the profit each year. There will not be $2.7 million in three years, there will be $8,600 in three years. Even at year 43 there will be less than $13 million.
Unless this investor knows the future with certainty, and no one does, many will quit before the end of the 50 years. Linear thinking coupled with impatience sabotages even the best of us.
The point of all this. Nobody can make 1.5% per month for a long time. It is a mistake to pursue things that are impossible. It consumes time and risks capital.
Making an investment return is not easy. It involves characteristics like patience, rational expectations, and persistence. Skill, knowledge and connections are a bonus.
Advisors make a good living helping people. They do so by supplying the missing skills and providing the conscience, which is just another way of guarding against impatience, fear, greed and irrational expectations.
If the farmer that owned the goose that laid golden eggs had had an advisor it is likely things would have ended better both for him and for the goose.
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Don Shaughnessy is a retired partner in an international public accounting firm and is now with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.