If someone had the choice between a $1,000 / month or a 1% monthly increase on their investments, which is the better choice?
The correct answer, of course, is “it depends”. If someone had $100,000 than 1% monthly would be $1,000. So if you have more than $100k, the increase is better, and if you have less than this the fixed amount would be better.
Mike touched on this in a previous post (Do you really “earn” your investment income?), but I think it bears repeating.
Some PF bloggers spend tons of time analyzing stocks and devising sophisticated strategies that incorporate geopolitical issues and long term forecasts of economics trends. Then you read that their portfolio is worth $24,000. Any benefit from their work is going to be minimal, simply because they have so little to work with. If they were to go out and earn minimum wage from their time, they’d be far further ahead than trying to “juice” the returns on a small investment.
At a certain point it DOES become more lucrative to try to enhance your returns instead of earn a salary. Warren Buffet earns $100,000 / year running Berkshire Hathaway. This is a tiny, tiny fraction of his 62 billion dollar worth. Clearly he isn’t going to work for this salary. He’s goes into work because he enjoys it and to increase the return of the money he has invested in his company. If he can enhance B.H. returns by 1% a year, he increases his net worth by 620 million (many, many times his salary).
For people trying to manage their finances, I think that when their net worth is low, they are better served to try to increase their income and not worry about their investment returns. Go with something simple like a high yield savings account, a money market fund, or a broad market index fund. Any effort you want to put into your finances will be best served earning or saving more dollars, rather than trying to maximize your return. If you have a negative net worth, paying down your debt is almost certainly the best place for your money, and I’d say it would be a no-brainer that you should just keep earning as much as you can, spend as little as you can, and apply the difference to your debt. If this won’t dig you out of your hole anytime soon, perhaps it’s time to look into bankruptcy.
The more your net worth grows, the more you should shift gears to try to find better returns. This could mean investment real estate, more sophisticated stock selection, asset allocation, or any of the other popular personal finance topics.
17 replies on “Labour versus Investment Income”
I like investing, but most posts about it make my eyes glaze over. This one did not 🙂 I totally agree with you about time put in with a low account value, although a lot of the time I put in is to learn and all part of that process. I don’t micromanage my money, I have a decent sum to work with and I enjoy it. But I don’t check it everyday and stay up at night worrying about what to do with it or analyze stocks incessantly. I own a few individual stocks that I had fun picking but it’s not part of my daily life. It’s not worth the “minimal” gains and losses right now. My dad, however, is my investing teacher and he checks his a lot and worries about it and puts a ton of time into it. Retired at 55, it’s his life and income though so it matters much more and he has a lot more to work with so that he can make a decision that equals the loss or gain of most people’s year salary at a day job. I’m babbling. I liked your post, Mr. Cheap!
I agree with Emily – great post.
Emily, you mention a good point – if someone is new to investing and is learning the basics, that might be a situation where it makes sense to spend a fair bit of time on investing even though they don’t have a big portfolio.
good point Emily.
The thing about investing is that saving is probably the biggest factor that will determine your success. Everyone wants good return on their money but if you can save money well you are way ahead of the game. If you are a good saver you’ll always have a large portfolio over time. Getting to the point where a 1% gain per month is more important to you than if someone gave you $1,000 per month is an awesome point to reach as a modest investor and good saver.
I should have included (thanks for catching it Emily and Mike) that two situations where it makes sense for people to be putting a lot of time into investing with small portfolios are: 1) they enjoy it & 2) they want to learn.
MG: I think you’re totally right.
Good post Mr. Cheap. I never thought about it that way.
It probably comes down to a control thing. People feel better if they are in ‘control’ of their investments (even if it’s just an illusion), whereas working a little bit extra feels like you’re giving up control.
While I agree that focusing too much on a small investment account can be a negative vs. work at a higher hourly wage and driving higher savings, no investor should discount the effect of compounding returns and how a CAGR can have a massive impact on how a portfolio performs over a longer time horizon.
I agree. Until you have a portfolio of $100,000 or so, most people should probably just pick a target retirement fund and forget about it. Unless you’re like me and just really enjoy researching investments.
If they were to go out and earn minimum wage from their time, they?d be far further ahead than trying to ?juice? the returns on a small investment.
True, but maybe the person enjoys doing the latter a lot more than they would enjoy the time doing the former. Most people don’t spend an hour on a blog post for the 50 cents in Google Ad revenue it may bring in. They enjoy that time.
But what you’re saying certainly rings true. The “best” thing to do with your money is almost 100% dependent on your situation. As a general rule, to anyone who has any sort of debt at all, paying that off is almost always a smarter move than trying to invest and beat your interest payments.
Great point Mr. Cheap, but I’d go a step further and suggest most investors would be better off if they left their investments alone regardless of their balance.
The vast majority of professional investors can’t beat a diversified array of low cost index funds. So why would any of us think we can outsmart the market?
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Totally wrong 😉
I spent heaps of time learning how to boost my investment returns when I was strating out and my total investment portfolio consisted of a few thousand dollar worth of stock. It pays off later on when you’ve built up your portfolio to a sizeable amount – better to make the inevitable mistakes of a newbie investor when you only have a small amount of money at risk!
BTW it’s not an “either-or” so of question. I spend time at work earning a reasonable salary, I also spend time monitoring my investments and trying to maximise returns (for my chosen risk level) and minimise costs (eg. fees and charges). I also spend some time earning side income (eg. blogging) even though the amount is trivial compared to my hourly wage rate and my investment returns.
What’s best – earning an extra $1,000 / month, or a 1% monthly increase on their investments, or BOTH 😉
[…] Labour versus Investment Income This is an excellent point, despite the misspelling of the word “labor” that you really need to establish a base of capital before getting excited about investing. No point in getting huge rates of return on a $1000 nest egg. Perhaps “no point” is too strong, but the point is dead on. […]
[…] Good on you, Mike!) A good analysis of where to concentrate one?s financial effort is here, in Labour vs. Investment Income. Some PF bloggers spend tons of time analyzing stocks and devising sophisticated strategies that […]
Great one cheap.
Harkens back to last week and the education vs. extra work comment. As a 20-something, my suggestion to most peers is to maintain positive cash flow and push for a bigger salary (so that they can save more).
We always talk about the “compounding effect” of savings. But a good pay raise can be better than compounding early on. In fact, spending money to earn a (mostly) permanent pay raise is indeed a form of compounding.
[…] Labour versus Investment Income […]
It is a great point about the investment returns. Although if you own a business or influence a business, I think there is an interplay between investment research and work results. I like Buffet’s quote, (roughly) “I’m a better investor because I’m a business owner, and I’m a better business owner because I’m an investor.” This year it has led to a bigger emphasis on exports, but you still have to consider the time vs. ROI.
if your portfolio is $100k, you’re mostly making way above minimum wage and the same argument still applies!