Gather ’round, it’s storytelling time. Today, we dive deep into two riveting tales of investment, each starting with $1MM and compounding over 50 years. Bear with me; there’s math ahead, but don’t worry – I’ve done the heavy lifting so you don’t have to!
Portfolio 1: The Steady S&P Investor
John is a believer in simplicity and consistency. With his $1 million, he opts to invest in the S&P 500 index, having faith in the long-term prospects of the U.S. economy. Over the years, he remains unfazed by market volatility, not once feeling the urge to tinker with his investment. While his friends sometimes gawk at new and shiny investment opportunities, John is content knowing that historically, the market has averaged about a 7% return after adjusting for inflation. He’s playing the long game, letting the magic of compound interest work in his favor.
To determine the future value after 50 years, we’ve used the following formula:
Future Value = P(1 + r)^n
Where:
– P = $1 million
– r = 0.07 (7% return)
– n = 50 years
Future Value = $1,000,000(1 + 0.07)^50 ≈ $29.457 million
Not bad for set it and forget it, eh?
Now let’s take a look at our second investor.
Portfolio 2: The Angel Adventurer
Sarah, on the other hand, is enamored with the world of startups. With her $1 million, she dives into the high-risk, high-reward realm of angel investing. She relishes in the stories behind each company, believing she can spot the next unicorn. And she does — a few of her investments skyrocket, yielding returns unheard of in John’s S&P 500 world. However, with the highs come the lows. Many of Sarah’s chosen startups falter and fail, leading to complete losses in those ventures. Over time, the wins and losses average out to an annual return that competes with more traditional investments, but with a rollercoaster of emotions and significantly more effort on her part.
Angel investment assumptions:
A few home runs with 900% (10x) returns, several decent outcomes with 200% (3x) returns, but many complete failures. On average, let’s assume a more volatile but comparable 7% return per annum, but with 20% drawdowns every 5 years due to a failed startup that she heavily invested in.
Her highs and lows average out to a volatile but similar 7% return as John – but what are the effects of the dreaded draw-down?
At the end of the same half-century, she’s down to $840,000. Yes, lower than her starting capital!
But, you say, she must be better than the market? I mean why would people even invest in startups if not to beat the indices?
This time, let’s assume Sarah’s golden touch yields a 20% annual return. But the twist? She still faces that pesky 20% drawdown every 5th year.
50 years later, her portfolio sits at $18,185,648.62.
Fantastic growth, but still less than John’s consistent march. But when we factor in time, stress, and other areas of non-traditional wealth, it starts to get ugly quick.
Now, let’s address the elephant in the room. A flat 20% drawdown every 5th year? Who comes up with such a simplistic model? Me, apparently.
But while it’s tongue-in-cheek (and not exactly how advanced portfolio modeling works), it drives home a crucial lesson: the staggering impact of losses on compound growth.
In wrapping up our tale, you might be tempted to think my strategy mantra is “All hail the S&P 500!” (à la Warren Buffett).
But I’m not here to trumpet the same old tripe. As the saying goes, never judge a book by its cover—or an email by its analogies.
And the fact is, if you are an entrepreneur, you already have a proven strategy to beat the market.
Curious about what that may be? Hang tight – next week I’ll reveal the most effective way for any entrepreneur to create generational wealth.
Compounding interest, not mistakes,
Mb
P.S. – While our story might be oversimplified, its lesson isn’t. Remember the first rule of the wealthy? Never lose money. Our tales today underline why this rule is golden.
