moneyFYI
Financial Freedom Is Merely Organized Common Sense
Which Would You Pick?
Would you rather have ten times your money in ten years or twenty times your money in twenty years? It seems like a silly question, but it offers some insight into how people think about risk.
If you have great faith in the future, you will always pick ten times in ten years because you expect to re-invest it at ten times in ten more years. Overall, a hundred times your money in twenty years.
Even after thinking about it, some people will still choose twenty times in twenty years. At least for part of their money.
It’s about reinvestment risk.
Ten times in ten years is 25.89% compounded annually. Twenty times in twenty years is 16.16%. Maybe where people make the 20x in twenty years choice is when they think, ten times in ten years and 7.17% for the next ten years after is the very same end as 20x in twenty years.
Their next question should address if the rate could drop from 25% to 7%, what else could it do? O%? Maybe lose money? At that point, 20x in twenty years doesn’t look so foolish.
Reinvestment decisions and expectations are an important part of investing.
Most investments have reinvestment decisions.
It comes down to a simple question. Asking, “Okay, what then?”
Should I reinvest dividends in the same company, or should I use the cash flow for something else?
What is my sell criterion? If a stock doesn’t make the hurdle anymore, do I have another stock in mind that does? Did I make the change because of empirical points, or did I just get bored?
Don’t forget about taxes when you sell a stock that has been a winner but now looks to be fading. Sometimes the one you have is better because of the tax cost to sell it. If you invested $25,000 a few years ago and it is worth $100,000 now, it will become $75,000 or less when you sell. The question becomes, which is better, $100,000 of old stock or $75,000 of the new? That leads to some challenging reviews of your numbers and estimates for the future.
Reinvestment assumptions and their meaning are challenging obstacles to financial success. They are harmful if you don’t think about them.
As with most financial problems, anticipating the possibilities minimizes their effect. You act sooner when adversity first appears and increase your investment sooner when an opportunity pops up.
The bits to take away
Most people don’t think about how reinvestment will affect them.
The longer you will be invested, makes the reinvestment problem bigger.
Learn to ask, “Okay, what next?
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I build strategic, fact-based estate and income plans. The plans identify alternate ways to achieve spending and estate distribution goals. In the past, I have been a planner with a large insurance, employee benefits, and investment agency, a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business. I have appeared on more than 100 television shows on financial planning. I have presented to organizations as varied as the Canadian Bar Association, The Ontario Institute of Chartered Accountants, The Ontario Ministry of Agriculture and Food, and Banks – from CIBC to the Business Development Bank.
Be in touch at 705-927-4770 or by email at don@moneyfyi.com.
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