Once people have established a firm financial base (debt at a comfortable level and enough savings to see them through a cashflow crunch), they should start investing. Investing is key for your long-term security. Taking compensated investment risk preserves your buying power. Hopefully, it will outpace inflation by a wide enough margin to help you spend more – either along the way or in the distant future. Despite knowing that, it is hard to pull the trigger. We can easily get in our own way with expensive self-talk and the media gets paid to scare us too. I am commonly asked, “I have some excess money, is now a good time to invest?”
With the firm-financial-base precondition, my answer is always “Yes.” I know that makes me sound like a sales broker who will always say it is a good time to buy or sell depending on whether the person asking is buying or selling. However, I will lay out my argument in this post. Decide if it makes sense to you.
Compound Growth Formula & Time
Everyone spouts about the magic of compound growth. It is common knowledge, but the human brain still has difficulty truly comprehending the impact. Unless they see it. Let me show you a picture of ten thousand dollars invested at a 5%/yr return compounded annually for 10 years.
After ten years, that $10K has grown to $16K. Pretty exciting you say? Boring I say! Check out how that $10K looks compounded over 50 years. That $10K grows to almost $120K! Those first ten years look pretty flat with $6K of growth. The final ten years are more stimulating with $40K of growth.
Time is the Most Important Variable
Why that tail-end lift-off occurs is really important. Below is the formula for compounding growth. There are two main variables: rate of return and time.
We spend a lot of time fussing over getting the best return. You can’t control what the market will return, but at least you can minimize what you lose to fees and taxes. On the other side of that variable is choosing a brokerage with enough support and an asset allocation to minimize your real-life losses due to investor behaviour. That is a complicated mix. Fortunately, the most important variable is time. Time is simple.
Maximizing Your Investing Timeframe
The most important variable in the compound growth equation is time. Time acts exponentially on the return rate. You can maximize your portfolio’s exposure to time by investing as soon as possible. Unless you are on your deathbed, it is never too late.
An important perspective to remember is that you don’t usually liquidate your portfolio all at once. Like on the day you retire for example. So, the tail end of your time frame is usually your lifespan. You can potentially extend that by investing in your holistic wealth to live a longer and happier life. This is what that $10K looks like if you invested it at age 25 and live to age 95. See, we all have some Warren Buffet potential. Even with only a 5%/yr return. We just need to invest and live long enough.
Procrastination Is Expensive
If you delay investing for longer periods of time and squander that key variable, there is a cost. Either in how much money you have later when you need it. Or in how much you must risk & sacrifice to get it.
The Price of Procrastination
It is easy to put off investing. The outcome is long-term and abstract. That is especially hard since we live in the present. There will always be things to attend to. Without removing money from our bank account into an investment account, we will inevitably spend it on something. There are powerful algorithms constantly bombarding us with opportunities to buy stuff that won’t make us as happy as we think it will. Even if our money just sits in cash, the more we accrue, the scarier it becomes to invest it. Further feeding the procrastination beast.
Below is how much less someone would have if they delayed investing for five years. That could be the consequence of buying a more expensive car for the average Canadian. Or a rockstar bus for a high-income professional. Both would have rusted to worthlessness after twenty years. Plus, more expensive maintenance. So, really a negative financial return. I am feeling merciful. So, I will just model sitting on cash earning nothing for five years.
The Lifestyle Cost of Catch-Up
A common cause for delayed investing is current spending. Spending money now is not necessarily a bad thing. If it is a time-limited opportunity that you will regret missing for the rest of your life, then that is important. If it will ultimately put you in a stronger position, that is actually just another type of investment. Education and skill development are good examples. Overall, the good news is that spending money in ways more likely to yield lasting happiness is usually not very expensive.
However, current spending does come at a cost. If it jeopardizes your future cash flow needs, then “future-you” will have to make sacrifices. Either by spending less and saving more before it is needed. Or making do with less when “the future” arrives. Unfortunately, the nature of compounding means that sacrifice grows exponentially.
For example, if I need my $10K investment to grow to $26K by 20 years. A five-year delay in investing means that I must invest ~13K at year five to make up for the lost compounding. In year five, I would need to sacrifice time working or by spending less to bridge that extra $3K gap. Let’s say I left investing until year 15 (with 5 years left before I need the money, it suddenly seems more important). Well, I had better really prioritize it because I would have to come up with an extra $21K to have my $26K in time.
That is double the sacrifice in 15 years. Either as earning more or spending less. Everyone is different, but I would be hard-pressed to work harder than I did 15 years ago. Or even as much. I would also struggle to spend half as much. We got some of our pent-up demand out of the way, but I now need softer beds while traveling and a carbon-fiber bike to keep up with my younger friends. Invest now. It won’t get easier.
But “Now” is Scary
I have shown you the math of compounding and the practical impacts that it could have. Still, there are a couple of problems with that. First, is that market returns are not linear. They go up and down rather than a smooth upward curve. Second, we are humans. That means that those ups and downs impact our emotions and behaviour.
Dollar Cost Averaging vs Lump Sum Investing
One of the answers to investing in a fluctuating market is dollar cost averaging (DCA). That is the concept of investing some money at a fixed time interval. For example, $1K every month. That way your thousand dollars will buy more units of your ETF when markets are down and all of your units will be worth more when markets are up. That works great when you only get access to that $1K once per month. It reinforces investment discipline.
However, the scenarios I have used today are if you have $10K to invest. A lump of money. Investing $1K per month for 10 months will mean that the bulk of that cash missed exposure to time in the market. The most important variable in the compound growth formula. That “cash drag” translates into less portfolio growth and the gap grows exponentially over time. Mathematically, lump sum investing will beat DCA. That also plays out statistically when you look at rolling 10-year periods of actual market returns.
Markets Are High & Buying The Dip
Despite the math & statistics, it is hard for us to mobilize into action. Humans are designed to recognize patterns. We see patterns that don’t exist. We also see past patterns and project them into the future. Evolution built our brains to do that. Unfortunately, it doesn’t work with enough precision for us to use investing.
Markets process all known information and probable outcomes so efficiently that it is reflected in the current price. The market price of an asset is essentially the weighted average of millions of investor brains. That is the efficient market hypothesis. It is false – markets aren’t perfectly efficient. However, those efficiencies are so small and fleeting that even professional managers cannot consistently capitalize on them enough to justify the effort and cost.
Markets fluctuate up and down in price. There are all sorts of explanations about why. Our brains are also wired to love stories. However, those explanations are retrospective and markets are forward-looking. You can bet that if you’ve heard it, read it, thought it, or didn’t even think it – it is priced in. Be confident in markets, not in your ability to predict the future.
“Markets are high” – that can be scary. We live in a world with gravity. However, markets go up ~70% of the time, and it doesn’t mean that they are about to drop. The most likely outcome is that they go higher.
“Markets are dropping because a scary recession is coming.” Or someone scary may win an election. Or Taylor Swift may cancel a concert, tanking the red sequin clothing sector of the economy. The odds and impacts of all those catastrophes are priced in.
You cannot tell when the next market celebration or tantrum is coming. Statistically, waiting to buy the dip, like DCA when you are sitting on a lump of cash is likely to lose for all of the above reasons.
How To Act Now
This post gave you the knowledge-base to understand why now is the best time to invest. Harness compounding and don’t try to outsmart markets. If you are still unsure, then you need to spend more time learning about the basics of investing. Perhaps even a deeper dive into key investing concepts. You have to educate yourself enough to be confident that you have a good plan and stick to it. Whether your are doing that yourself or through an advisor.
Compounding returns are powerful. By investing and taking advantage of that miracle, you could have more in the future. Or be able to earn less or spend more on your journey to financial independence because it is working for you. The most important variable in the compounding equation is time. It acts exponentially. That is why the best time to invest is now to maximize your time frame.
You cannot undo missed opportunities to invest. So, don’t waste time beating yourself up over that. Move forward. Don’t let news or market highs or lows deter you or justify procrastination. Remember how expensive that is. Perhaps this post will help you to take the leap, if you are sitting on a lump of cash. That has the best odds of success, but leaping is scary.
If you are too nervous and sitting on cash, then dollar cost averaging with a deadline is certainly better than doing nothing. Make a goal of when you want to be fully invested by, and implement it. For example, invest 1/4 of your cash every month for the next 4 months. Then, continue to invest regularly moving forward whenever you have excess cash to invest. Preferably, with automatic deposits to get it out of your bank account before the algorithms get you.
