A question from a reader made me think that perhaps I needed to expand a bit on the importance of setting realistic goals. For example, my goal is to earn 12% a year with my entire portfolio and I break that down to an objective of 1% a month. A reader wrote in wondering if that goal changes with inflation. Here is the question from the investor.
Reader’s Questions On the 1% A Month Objective
After I read your article (my Strategy Explained) about the aim is to make 1% (as a minimum) per month, I was wondering if that is still your aim, as I understand we are experiencing (or will experience) higher inflation.
The Goal Must Be Realistic
The goal of 1% a month actually has little to do with inflation and more to do with being realistic when setting goals. In the 1970’s when I started investing, it seemed unrealistic to aim for 12% a year. First, there was the problem that options were an over the counter product and had limited volumes as well as limited stocks to trade against. There was also the problem of higher commissions because back then there was no such thing as discount brokers.
But setting a goal that can be reached is important not just for the growth of my portfolio but also psychologically for the investor. It is important to set a goal that can actually be reached, not just once in a while but every year. Perhaps your goal is 5%, 8% or 10%. There is nothing wrong with setting a goal that may seem low because by setting a goal of 20% or more each year you are already setting yourself up for disappointment.
When the goal can be realistically achieved, I do not take chances and risk my capital in stocks that I would normally not trade. By setting a realistic goal I derive great pleasure out of beating that goal. By setting a realistic annual goal like 10 or 12%, it gives an investor the opportunity to break that goal down into monthly or even quarterly periods. I prefer monthly and as explained in my original strategy article which you can read through this link, I find that I can then concentrate on a variety of positions. Some will bring in only half a percent in a month while others will bring in more. When combined, all my trades work together to earn that 1% each month.
Inflation Is Not A Factor
Inflation is not a factor in my 12% goal. I have had the same 12% a year goal since the mid 1970’s. Interestingly in the 1980’s as inflation took hold and interest rates sky-rocketed under Fed Chairman Paul Volcker, making 12% a year was very easy.
The 12% Factor
12% a year is actually an incredible return when done consistently year after year. Let’s look at what any investor can accomplish by earning 12% a year. The amounts in these tables would actually be higher because if I earn 1% each month on my investment, that 1% compounds monthly. For example I am presently working with $850,000. 1% for the first month would be $8500.00. This means I have $858,500 for month two. 1% for month two then is $8585.00. For month three then I have $867,085. For the third month 1% is $8670.85. I am sure you can see where this is going. I am going to earn more than 12% at the end of the year. Now imagine that compounding effect month after month.
Let’s look at some figures. I started out with $25,000.00. Here is what 12% earns on an annual compounding basis over 38 years without any additional capital being used. Only the compounding of the original $25,000.00 is used to grow this portfolio. The total return from an initial investment is $1,854,492.00. If inflation averaged 3.7% for the 38 years, the total buying power in the future would be $466,264.00. (far right column)
Compounding Of An Initial Investment of $25,000 over 38 years at 12% - no extra funds added.
38 Years With Additional Capital
If you add $200.00 each month over that 38 years the return is almost double at $3.4 million and after inflation buying power of $858,000.
Compounding Of Capital over 38 Years at 12% with additional $200 every month added.
Realistic Goals Work
Setting realistic goals work. For example recently I had an investor write to ask me if I thought $3000 was enough to start with. My answer would be to do an online search and find a financial compounding calculator. That calculator can be used to give an investor some idea as to how much they will need to invest monthly to grow their investment over a set period of time. That type of calculator is excellent for allowing an investor to set out a plan whether it be 10 years, 20 years or as in my case 40 years. You can then quickly see how much capital you will require to meet your goals.
Below is the chart of a $3000 initial investment compounded over 38 years. You can see that if inflation averaged 3.7% the buying power is small at roughly $56,000 despite the compounding of the original capital to $222,000. This immediately tells any investor that they must add additional capital monthly or at least annually to really grow their capital.
Compounding of an initial deposit of $3000 over 38 years without adding any additional capital
Inflation and a Realistic Goal Summary
By setting a realistic goal and then using a simple calculation anyone can become a better investor. By using a simple calculation an investor can decide the best course for his money, which may actually end up not being in stocks at all. Remember that not everyone needs to invest in stocks or ETFs, particularly when you consider that the returns of the market index ETFs have been terrible depending on when an investor started. For example, imagine the dismay if an investor had bought the S&P 500 index ETF in December 1999. The S&P was at $1469.25. Now 13 years later the S&P 500 is finally at $1500. Even with dividends and monthly contributions the results are very disappointing for 13 years of investing. Time is everything in investing. To earn 4% on average over a 13 year period of time versus 12% over the same period is incredibly poor. This is just another reason I am not overly interested in ETFs.
Many investors feel ETFs are “safe” investments, but many times that safety comes with lower performance factors. I prefer my strategy of aiming for 12% against large cap stocks and letting my capital compound every year. I do not want to simply invest and then watch for years while my capital fails to grow as quickly as I want. Every year of poor growth is another year lost from the power of compounding of wealth.
This article went beyond the reader’s question but I think it was good to study why inflation for my method does not factor in and why I believe a realistic goal is very important when it comes to investing, especially for the long-term.