Stashing away money for a rainy day is a concept that is valued – at least in theory – even by Normies. Putting money in a coffee can or a non-interest-bearing Disney Vacation Account1 is essentially risk-free and is a tiny bit more effective than buying unneeded stuff: It’s not index fund-smart, but it’s a start. Savings like this are like Bruce Banner: Smart – but not as smart as Tony Stark – and safe, but with none of the reward that comes with keeping precarious allies like the Hulk. (For those with lives: The Hulk is nearly invincible and has incredible physical strength that grows with his rage and has no upper limit. The guy can lift planets.)
In finance, compound interest is powerful. Really – it’s the Hulk.
Both are unreasonably powerful. Relentless. The Hulk lifts planets; compound interest runs them. And to get the benefits of having the Hulk on your side, you have to accept the risk that he’ll direct his anger your way. Similarly, to get the power of compound interest on your side, you have to accept the risk of losing a chunk of change at times.2
The trick to keeping the Hulk under control is, well, you don’t.3 The trick to keeping compound interest under control (without opening your own bank) is to accept the risk and not fight it. You need to make steady, effective use of a wealth-building tool traditionally reserved for wealthy gamblers: the stock market.
Step 1: Understand the risk.
Here’s the thing: Most people lose money in the stock market, and lots of it. They lose because they focus on the short term. In an attempt to make a quick buck by outperforming the expected ~6-7% average gains of the market,4 they try to pick winners and losers in stocks and mutual funds. But they can’t predict the future, and neither can the fund managers.5 They try to time their entry in the market to get the greatest gains. They buy when the market is booming, thinking that it will keep booming, and they sell in a panic when it falls, heeding the Normie call that every drop is the end of the world. They act like this.
Frankly, it is best to ignore all financial advice and stock tips out there.6 No one knows who will succeed and who will fail, and nobody knows whether the market is headed for a steep climb or a cliff-dive tomorrow. As usual, the people who pretend to know everything are dangerous and deserving of your skepticism. Even the prodigy mutual fund manager who comes to you with a perfect record – begging to make you rich out of the goodness of his heart, for a nominal fee – will soon be revealed as a con artist.7 Cut through the noise; noise is for Normies.
Step 2: Don’t fight the Hulk.
Imagine you suffered severe brain damage and bought a TV on credit with the intention of making minimum payments until it was paid off.
You unleashed the Hulk on yourself. If you fail to pay off that TV quickly enough, you’ll pay interest. And credit card interest is ridiculous. Typically, you’ll owe somewhere between 10% and 30% of the balance as interest, which is added back to the balance of what you owe so you can be charged interest on that, too! A TV valued at $1,000 in the store (which is a bit ridiculous in the first place, but that’s another topic) could cost you $2,056.708 if you make monthly minimum payments on a great card with 20% interest! See why compound interest is so powerful?
So long as that big green guy is working against you, you can’t get ahead. If you’re paying 20% interest on a credit card each month to sustain your current standard of living, you need to increase your income equally just to stay afloat. Which, let’s face it, isn’t going to happen for most of us. When was the last time you obtained a 20% raise at no cost to yourself?
Step 3: Embrace the Hulk.
The Vigiliante’s gonna let you in on a little secret now, so lean in close: The market always goes up!
That doesn’t sound right, does it? I mean, is The Vigilante blind to the millions of people who have lost billions of dollars in the stock market?
I assure you, I’m not. And I can prove it.
Whenever you buy stock in a publicly traded business, you agree to the value of that business based in part on its assets – from things it has to things it is legally entitled to collect (like accounts receivables). We value the business at what we do because we assume that, if the business stopped operating and growing today, it could collect debts, liquidate its other assets, and pay out that much value to shareholders.9 It doesn’t always work that way, but that’s part of our gamble.
Obviously, some businesses do become worthless. Others become more and more valuable. Rational people always seek ways to make a living, so when once business closes another will eventually absorb the displaced workers. Given these truths, there are only two ways the market could stop going up:
- All debtors cease to pay and all consumers cease to consume.
- The entire country is overrun by roving bands of zombie motorcycle gangs that value only one asset: brains.
As long as the entire economy doesn’t cease to function, the consumers make money. The debtors can and are legally required to pay.10 The market will rise, because businesses will keep producing, keep being valued based on their ability to generate a profit for owners, and keep selling shares of ownership in pursuit of capital to use for expansion to make even more money. Greed is great, isn’t it?
Contrary to popular Normie belief, the evidence actually supports that the market always goes up. This is the entire history of the Dow Jones Industrial Average – an index of 30 of the best-performing companies in the NYSE11 – since January 1914 in one handy graph:
You may know that it has grown from the 12 best-performing businesses to the 30 best-performing. It’s true: It began as an index of the 12 best and was increased to 30 during the “Roaring Twenties” (that steep climb in the above graph just before it hit 4,000 for the first time). This doesn’t really affect the validity of the claim that the market always rises: Just look at post-Depression gains.
You may also notice that the top of the graph is all mushed together. This isn’t statistical bullying – it’s actually hugely significant that the data wouldn’t fit on a reasonably-sized graph without this modification. The gains in the DJIA have been so big since its inception that each decade that passes leaves the previous looking like a straight line with little detail – even when controlled for inflation, like this graph! Greed is so, so good!
So, despite periodic dips, the march upward continues. And logically, it always must. Until the motorcycle zombies come.
Step 4: Minimize your risk with index funds or doomsday prepping.
That power that worked against you when you purchased the TV on credit can be turned in your favor. Stocks are the easiest, most risk-free way to do it, since you’re basically betting that the economy will exist for the rest of your lifetime. And if it doesn’t, then I hope you’ve stocked up on shotgun shells and gasoline, because life ain’t pretty for anyone when the zombies come.12
We know that, on average, the stock market will go up. But there is no risk-free investment. How much it goes up – and how that increase compares to inflation, which devalues your money – determines how much you can draw from your investments without draining your savings prematurely, which is the “risk” we’re all concerned with.13 That amount you can withdraw is your safe withdrawal rate, and it’s impossible to pin down without any risk at all since nobody can predict the future. Luckily, we have the Trinity Study to guide us.
The Trinity Study is a number-crunching game played by nerdy finance professors at Trinity University in 1998 and 2009. It evaluates – with and without inflationary adjustments – the performance of fictional portfolios with different mixes of large-company stocks and high-grade corporate bonds over any 30-year time period from when withdrawals theoretically began. If a 30-year period resulted in no more money, then the portfolio failed. If money remained, the portfolio didn’t fail.
The majority of the time, at any withdrawal rate lower than 7%, the inflation-adjusted model showed that the portfolio actually gained value in the 30-year period. Success in terms of not running out of money was as close to a sure bet as you’ll ever get as the withdrawal rates approached 4%:
The gist of the Trinity Study results: You can very safely assume a return of 7% per year between dividends and price increases, all the ups and downs of the stock market considered. Take out 3% for average inflation, and you’re left with 4% to spend, for every year from now until entropy ends the universe.14
This suggests, if you spend $30,000 per year now, a $750,000 portfolio of 50/50 stocks and bonds has a 96% chance of covering you (at your current spending plus inflation) until 2045. (Or really, covering you for life, as the odds change by almost nothing beyond 30 years.) That is, your portfolio will cover you even if:
- You never earn another penny through part-time, full-time, or fun and optional work.
- You never collect Social Security or a pension.
- You never decrease your spending on purpose, such as to compensate for a temporary economic recession.
- You never decrease your spending by happy accident. (Which you are very likely to do – retirees tend to spend less because of reduced driving, reduced need for clothes/equipment/other work-related expenses, and reduced stress/increased ability to appreciate life without paying someone to appreciate it for you.)
- You never collect any kind of windfall. (Things like inheritance, gifts, lottery winnings, finding a dollar on the street.)
Of course, if a bet that heavily in your favor is unsavory to you, there is always doomsday prep.
- It’s a real thing, but I have too much pride and self-respect to link to this monstrosity. Google your options for financial suicide on your own time.
- I’d argue that it’s far more risky to not invest money, even in volatile stock markets, as your chances of wasting precious time in pursuit of money increase dramatically with every dollar you spend instead of keep. But, for the sake of metaphor, I’ll accept that a stock portfolio carries slightly more “risk” than a coffee can (which I personally find more risky to my time, as it’s a guaranteed loss thanks to inflation).
- But it helps to have a love interest for his alter ego and all the mushy, predictable, love-conquers-all Holleywood tropes in your back pocket.
- The value of the market as a whole reflects the value of all publicly traded companies combined, and index funds exist to track the performance of any group of stocks you can imagine – including all of them.
- Not that they don’t try. These guys can be really, really smart. A fund manager’s brain must look like a CSI investigation room, with charts and photos pinned to the wall, and yarn linking this document to that person, to that merger, and back to another person, etc.
- I am well aware of the hypocrisy here.
- Seriously, click on it. That post is one of the most valuable, humbling things you can read on the internet.
- $1,000 balance, 20% interest rate, minimum payment of interest plus 1% of balance. Bankrate.com.
- This is absolutely not the sole measure or source of value of a company – for simplicity, I’ve conveniently left out cash flow, dividend valuation, and pure, wild speculation – but assets are at the core of any business valuation, by necessity, even though it is not explicitly stated that way. An entity that can’t produce money for owners now or in the future is a charity, not a business. Not that there’s anything wrong with charity – it just won’t help you tame the Hulk.
- I know, “But sometimes people don’t pay debt! Houses are foreclosed on! Student loans are forgiven!” To which I respond: Yes, but a foreclosure means the loaner will reclaim the tangible property and attempt to collect that value from another person instead of the original borrower. The value doesn’t simply disappear. Student loans are forgiven, but by government entities that know there is a certain negative value associated with loan forgiveness programs, and so they collect the value from another source to compensate. Put simply: taxes on other good and services are higher to compensate. Which is why, my fellow young college grads, student loan forgiveness is such a bad idea.
- The number of businesses reflected in an index is relatively insignificant for our purposes here. Much like the failure of a company results in another absorbing the displaced workers, the failure of a business in an index like DJIA or the S&P 500 results in another business rising to take it’s place in the index.
- Interestingly, the most well-prepared people in the event of zombie apocalypse would probably be those who had a lot of free time to learn and grow instead of heading to an office job daily. So, even if you believe that our future is a barren, zombie-filled wasteland, you should probably shoot for saving 20-25 times your annual expenses, anyway, so you can start practicing your survival skills ASAP.
- There are other big drags on your ability to withdraw, such as fund manager’s fees, taxes, and penalties on “early withdrawals”. For the most part, though, these aren’t of much concern to a Vigilante, as Vigilantes don’t pay someone else to play with their money, don’t require so much money to live that they pay atrocious tax rates on withdrawals, and cleverly plan in advance to avoid penalties as much as possible.
- My words, not theirs.