A couple of years ago, an Army friend asked me:

Index investing sounds great and all, but when you buy the index, you’re just settling for average returns. Why would you settle for average when you can get above-average returns by picking stocks?

On the surface, that seems to make sense. Why would you settle for a boring 5-7% return when you can get 10-12% through value investing / forex trading / tactical asset allocation?

Getting a great return is awesome. But how important are they to your overall wealth?

**Let’s Math This Problem Out**

When I was in Primary 4, I fell asleep during my math test and failed it. My teacher scribbled “*Lionel is not interested in math*” and made me take it to my parents and sign it.

To prove my Primary 4 teacher wrong (and because there’s nothing more motivating than my childhood insecurities), I’m going to use math to answer this question.

So! Here’s our math question for today: Xiao Ming invests $12,000 every year at a return of 5% a year. How much will Xiao Ming end up with after 20 years? (I bet there are Primary 2 math questions out there today that are way harder than this one*)*

We can use a single formula to answer this question (take *that*, Mrs Lau!)Don’t worry, it isn’t as complicated as it looks:

- W is your wealth
- I is how much you invest every year
- r is the returns you get from your investments
- t is the time horizon you invest for

So all we gotta do is plug in Xiao Ming’s numbers:

As my French colleague likes to say, *Wa-la!* We find that Xiao Ming ends up with a nice stash of $396,791. Not too shabby.

**Let’s Flip The Numbers And See What Happens**

Now, let’s do a Missy Elliot and put that thang down, flip it, and reverse it. Is it better to get 5% a year for 20 years, or 20% a year for 5 years?

Let’s take Xiao Hua, who isn’t satisfied with 5% a year and now trades forex. Let’s assume that he’s *really* good at what he does and gets *20% a year for 5 consecutive years*.

(By the way, if you can get 20% a year for 5 consecutive years, you’ll soon have rich people knocking on your door asking you to invest for them).

Let’e see what happens when we plug Xiao Hua’s numbers into our formula:

Booya! Xiao Hua’s amazing 20% per annum strategy yields just a little over $89,000 over five years. Getting 20% returns per year might SOUND sexy, but unless it’s *sustainable*, it doesn’t amount to very much.

The truth is, getting these sky-high returns isn’t very sustainable at all. At those levels, you’re likely 1) Taking on a huge amount of risk, 2) In a Ponzi scheme, 3) all of the above. And unless you’re Warren Buffett, it’s unlikely that you’ll get returns that will beat the market over the long run.

**Pick A Sustainable Strategy, Not A Sexy One**

Which brings me to my point: Lots of people are obsessed with finding the sexiest investing strategy that will bump up their returns by a couple of percentage points: Smart beta! Momentum! Tactical asset allocation! Forex trading!

But instead of asking, “Which strategy will give me the highest returns?”, it’s much better to ask, “**Which strategy can I stick with for the longest time?**”

As the numbers show, your **time horizon –** not your returns – is the key differentiating factor. The longer you can stay invested, the greater the compounding effect, and the greater your wealth.

[…] By Lionel Yeo […]