Why I am not afraid of losing money
A couple of days ago, I was having dinner with my two college friends Christa and Caroline. We were drinking the delicious and healthy aperitif Christa had prepared while enjoying the Zurich lake view from her balcony.
We started talking about our latest life happenings and concerns. Like many women in their mid to late thirties, they are both keen to take charge of their finances, stop wasting and losing money, and start planning for the future.
Christa and Caroline were both curious and intrigued when we started talking about investing.
But as I went on to explain the why and the how, they both voiced the same concern, one that I can relate to having had the same question in my head for many years:
I would like to invest, but I am just waayyyy too afraid of losing money.
I went on to explain that with a passive strategy, low costs investment funds, and an investment horizon of at least 20 to 30 years, this was quite unlikely. But this is such a big concern for so many, that it is worth illustrating it with a story.
Roberta of the odds of terrible timing
Have you ever heard of ‘Roberta,’ the world’s worst market timer? Actually, the story is usually told using the name ‘Bob,’ but I thought a female name was appropriate here!
Each time Roberta invested in the stock market, she did so just before a market crash.
At the end of 1972, the 22-year old Roberta invested $6,000 in the stock market and then saw her investments decrease by 50% shortly after that.
This was disheartening. But Roberta decided to invest all her savings, $46,000, again in August 1987. As luck would have it, she did so just before the stock market crashed by 30%.
Despite her past experiences, Roberta gave it another try in 1999 when she invested $68,000. Then again, she saw the stock market decline by 50% shortly after that.
Finally, she invested again $64,000 in 2007 at the peak of the market. And as you could guess, she did that just before the stock market crashed by more than 50%.
Now that’s a lot of bad luck…
But despite having invested at the worst possible times, Roberta still managed to retire with over $1.1 million in 2013.
Had she never invested at all, she would have retired with only her savings, totaling $184,000.
What Roberta did well
How is that possible? How did Roberta manage to accumulate so much wealth? Well, in spite of her terrible timing, Roberta made a few right investment decisions.
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1 - The magic of passive investing
Rather than trying to select good stocks, Roberta chose to invest in an Exchange Traded Fund (ETF) tracking the S&P 500 index.
This means that she put her money in a diversified fund, which gave her a broad passive exposure to the US stock market.
It was the right decision because passive investing has been proven to return a superior performance over time when compared to active investment strategies.
Although it might seem counterintuitive, this means that stock picking, even when done by professional and experienced traders, typically returns less money than just investing in the stock market as a whole.
But what kind of returns are we talking about? Well, in the last thirty years to May 2018, the S&P 500 index returned an average of 10.5% to investors on an annual basis, assuming all dividends were automatically reinvested.
2 - Low fees or the best-kept secret
Also, by choosing to invest in an ETF rather than a traditional investment fund, Roberta put her money in a type of investment fund that charges low annual management fees.
This is equally important because numerous research papers have shown that fees have a tremendous impact on overall performance, especially in the long run.
For more insights on the tremendous and often misunderstood impact of fees on investment performance, read my other blog post: I Hate Fees and So Should You.
3 - Start early and stay in
Another thing that Roberta did right is that she started investing early. She also did not chicken out and sell her investments when the stock market was going down.
By never selling anything, she allowed her investments to grow and compound during her 40 years of investing.
‘Compounding’ means that an investment earns a return not only on the amount initially invested but also on the accumulated earnings of previous periods.
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Let’s take an example. If you invest $10,000 now and earn a 8% annual return, this is what would happen:
After Year 1: $10,000 x (1 + 8%) = $10,800
After Year 2: $10,800 x (1 + 8%) = $11,664
After Year 3: $11,664 x (1 + 8%) = $12,597
After Year 4: $12,597 x (1 + 8%) = $13,605
After Year 5: $13,605 x (1 + 8%) = $14,693
And the magic of compounding amplifies the longer your money is invested. After 30 years, you would end up with a mind-blowing total of $100,627.
NOT afraid of losing money
This is why I am not afraid.
So now you understand why I am not afraid of losing money with my investments. And you should not be either!
Like Roberta, the odds are in our favor if we 1) invest passively, 2) choose low-cost investments, and 3) invest for the long term.
