One of the most overlooked parts of investing is trying to figure out what your return is going to be.
Indexers don’t care about this, for obvious reasons. They buy the index, take their pants off, and get to enjoy a hell of a lot more relaxing time than us active investors. It’s okay though, they’ll probably just waste that time playing some game on their phone that came out in 2012 but they’re just finding out about today. Suckers.
Here’s the way I do it as a value investor. I look at a company and try to figure out what it’s worth in an ideal world. I look at things like the price it used to trade at, the valuation it had when it was higher, and so on. Sometimes, the target price will be as simple as book value.
Say I buy a stock for $18 and I think the value of it is $30. I figure it’ll take between 3-5 years to get there. Thus, my annual return looks to be between 11.5% and 19%, plus any applicable dividends. My goal is to compound my wealth at a 10% clip over time, so I’m happy with this.
Many investors don’t bother with such a calculation, mostly because it’s not so precise. A lot of things can happen over a couple of years, throwing my crude expectations out the window. And what happens if the thesis doesn’t look like it’s playing out after three years? Do I sit and be patient, or do I move onto other opportunities?
These are all questions good investors will ask themselves. We might not have the answers, but it’s important to ask the question.
People will often make a similar type of calculation when it comes to some sort of active investment. Because this is a blog, let’s use buying a blog as an example.
On the surface, buying a blog looks to be a kick-ass investment. The standard price to pay for one is apparently 20x monthly profits, but I’ve seen them go as low as 6-12x monthly profits. If you buy the right blog, you can get your money in half a year, a cool 200% annual return.
That’s a lot. I once claimed I’d strangle a hobo for an 18% guaranteed return. What would I do for a 200% return? I’d probably murder my whole family.
There’s just one problem with buying something like a blog. It’s the same problem with buying any sort of business. You have to work at it.
For many people reading this, spending time on something isn’t a problem. I’ve argued a million times that we all piss away more time than we realize. You’re not reading this if you really have something pressing to do. If you’re under 30, chances are you have the free time and ambition to tackle multiple projects.
But at what point is it not worth it?
Investing the time to learn
Over the years, I’ve spent thousands of hours reading, thinking, and talking about investments. I might not be up to Malcolm Gladwell’s 10,000 hour expert mark, but I’m getting close. I can tell you all about investing in real estate, stocks, mortgages, preferred shares, and probably a few other asset classes.
I didn’t really set out to learn all this stuff. I was interested in it, so I read up on it. Becoming good at it was a fortunate accident. The primary goal was to be entertained. Yes, I am the kind of guy who reads about investments for fun. No wonder I was single for so long.
When I was 18 and $10,000 was all the money I had in the world, a smart decision would have been to stick it all in an index fund and call it a day. If I can expect that index fund to return 8% annually over the long-term and I want my portfolio to do 10%, it doesn’t make sense for me to invest all those hours into my education to get 2% extra — at least in the first few years.
If I can beat the market consistently over time, then perhaps all the time I spent educating myself does make sense. As long as I invest enough, that is. If I only put $100,000 into my retirement fund over my lifetime, investing 5000 hours into growing it at a pace slightly higher than the market doesn’t make much sense. If I spend 5000 hours to increase my portfolio by $50,000, I’m barely making minimum wage.
We need to factor in the amount of time dedicated to something before we go investing in it. Investments can be passive or active. Business ownership can be passive or active. There’s a huge difference in time invested between buying an index fund and researching the hell out of a stock.
It’s even worse when investing in a business. There’s a reason why blogs sell at between 1-2 times annual earnings. Not only do they take work to maintain, but there’s also a limited number of people who can feasibly own one. My Grandpa barely knows what the internet is; there’s no way he’s buying a blog.
The time factor is why certain investments look better than others. Just be sure that when you buy an investment that requires you to be active, you get compensated more for it. If not, what’s the point of doing all the extra work?
Rate of return on your money is just one factor. You also have to look at the return on your time. A good investment for me is one that has a high rate of return on my money, without having to spend much time managing it. There are many investors who are looking for something like that. But there aren’t many looking for something that takes time as well as capital. Perhaps that’s where you should look, provided you have the time.