The One Factor That's More Important Than Your Annual Return

It is common wisdom that the longer you have to invest, the more risk you can take - because if you lose money, you have plenty of time to make it up. And that's true. But that's not the full story.

Last week, I traveled to The Oxford Club’s headquarters in Baltimore to give a presentation to the employees of its parent company about its 401(k) retirement plan. I put together some numbers, and what I found surprised even me, who literally wrote the book on investing for the long term (second edition is coming out Feb. 24).

It is common wisdom that the longer you have to invest, the more risk you can take—because if you lose money, you have plenty of time to make it up. And that’s true.

But what is also true—and what most investors are never told—is that the longer you have to invest, the more conservative you can be and still get rich.

Here’s what I mean.

If an investor puts $10,000 to work and, every year for 30 years, invests an additional $2,000, earning 8% on his or her money, the total sum would be $345,318.

But 8% is significantly underperforming the market.

Over the past 50 years, including dividends, stocks have returned about 10% per year. So if an investor is earning only 8%, they are earning 20% less than the market average. They have either picked the wrong investments or have invested very conservatively.

If another investor delays investing for 5 years, but then earns the market average of 10% per year, which is 25% higher than the first investor, they still wind up with less than the other guy. That’s right. The investor who invests for 25 years and earns 10% each year finishes with $324,710.

So even though they earned a higher rate of return every year for a quarter of a century, by delaying investing 5 years, they made $20,000 less.

And an investor who earns 12%, but invests for only 20 years, ends up with $257,860. In this case, they outperformed the market by a meaningful margin and made 50% more than the first investor on an annual basis. But their nest egg is 25% smaller because they waited 10 years to invest.

Another way of looking at it—in order for someone to get the same $345,000 as the “30 years at 8%” investor, an investor would have to earn annually...

10.3% for 25 years

14% for 20 years

20.5% for 15 years.

The investor who invests for 25 years has to slightly beat the market over the entire lifetime of the investment—certainly possible, but not easy. The investor who waits 10 years and invests for 20 years instead of 30 has to make 14% per year, which is a very strong return. Again, it’s possible, but not very likely.

In fact, it’s kind of like a career .320 hitter in baseball. If you earn 14% per year for 20 years, you’d be going into the investing Hall of Fame (if there were one).

And if the investor waits 15 years, they need to earn the nearly impossible 20.5% annually. To continue the baseball analogy, you’re not just in the Hall of Fame, you’re Joe DiMaggio or Ted Williams—one of the absolute greatest to ever do it.

So the longer you invest, the worse your results can be—and you’ll still achieve your goals.

That can mean taking some speculative chances. If they don’t work out, you still have other investments that will make up for it, plus plenty of time. And if some of them do pay off, your returns will be even greater.

But it can also mean you can be conservative if that’s your style. I don’t particularly recommend being conservative for decades, but for some people who are not comfortable with much risk, investing conservatively may make sense. And knowing that they can invest conservatively and still hit their goals may be just what it takes to get them to commit to investing for the long term.

The lesson here is that the length of time you invest is one of the most important factors in investing success—even more so than how well you invest.

And for those of you who don’t have a 30-year investment horizon, I’m sure you know someone who does. Get them started investing at a young age, because the results can be very substantial.

That investor who underperformed the market at 8% a year for 30 years—if they added just 10 more years, their $345,318 more than doubles and becomes $776,807.

Invest for the long term and get your younger family members to do the same. It’s the gift they’ll appreciate for the rest of their lives.

Marc Lichtenfeld is chief income strategist at The Oxford Club.This article originally appeared at InvestmentU.com. Reprinted with permission.The information contained in this article should not be construed as investment advice or as a solicitation to buy or sell any stock. Nothing published by Physician’s Money Digest should be considered personalized investment advice. Physician’s Money Digest, its writers and editors, and Intellisphere LLC and its employees are not responsible for errors and/or omissions.