Should I Take Shots With My Investments When I’m in My 20s?

Moon
Shoot for this?

“Risk comes from not knowing what you’re doing.”
–Warren Buffett

“We will either find a way or make one.”
–Hannibal

I recently read the story of Sam, who became a millionaire by age 30. He has a ton of great life lessons in there (skip down to the part titled “Some Thoughts on Building a $1 Million Nest Egg Before 30”) about what sort of work ethic it takes to get ahead.

One of the points that he brings up is that at age 22, he invested $3,200 and turned it into about $200,000. He admits he was lucky (after all, you do, statistically speaking, have to be lucky to beat the markets, particularly over time), but that enormous boost gave him the platform from which he was able to turn that $200,000 into over a million dollar net worth in another six years – no easy task in itself, either.

Of course, for every Facebook or Tumblr founder, there are a lot of people who take shots and wind up failing with those shots. When I first started investing, I took a shot and watched it bleed away to $0 when the stock I invested in declared bankruptcy. I then waited until my early thirties to take my next shot, and I eventually was able to grow and then sell my business and achieve financial independence.

So, I am a walking example of what Sam discussed, even if I took my shot a little later in life. When taking the shot works, it’s great.

But what happens when taking the shot doesn’t work?

For the Sams out there, there are many more anti-Sams, people who think that they know what the next big thing is before the rest of the world catches on, only to find out that the world already knew what they didn’t, and their swing-for-the-fences money shrinks substantially. If they go all in when they’re young, does it really help or hurt them in the long run?

To evaluate this, I created a model to project into ten thousand different futures. This is called Monte Carlo modeling, and it uses random number generation to forecast what would happen given a set of scenarios.

In this case, I decided to create three parallel scenarios. All of these involve someone who is currently age 26, has $5,000 a year to invest, and will work no later than age 65. The ideal target “retirement number” is $2 million (to read why the target number isn’t necessarily the retirement goal to focus on, check out “Why You Shouldn’t Obsess Over Your Net Worth”):

  • Scenario 1: Invest the $5,000 per year in the market and achieve market returns. The average S&P 500 historical return since 1871 has been 10.6%, with a high return of 56.8% and a low return of -44.2%. The simulation generated a random number averaging 10.6% and ranging somewhere between the high and the low return.
  • Scenario 2: Between ages 26 and 30, take a swing-for-the-fences shot. Invest all $5,000 in a speculative investment that had a 10% chance of a positive return between 100% and 1000%, averaging 300%. When the “shot” failed, the loss ranged from 0% (breakeven) to -100% (losing it all), averaging a loss of 30%. Remaining money, e.g., the returns on the “shots,” was reinvested in the stock market.
  • Scenario 3: The same as Scenario 2, except if one of the “shots” had a positive return, thank the Wall Street Fates and stop taking “shots.”

After 10,000 simulations, I looked at how each scenario played out and how our person ended up at age 65.

The person who took no shots wound up with an average net worth of just over $2 million. The median net worth was $1.35 million, meaning that 50% of the scenarios saw this person with less than $1.35 million, and 50% of the scenarios saw this person with more than $1.35 million. The net worth ranged from $72.8k to $33.7 million.

About 65% of the time, our “conservative” person didn’t reach the target net worth.

The person who took shots every year between ages 26 and 30 wound up doing slightly worse, on average, than the person who took no shots. The average net worth was just under $2 million and the median net worth was $1.32 million. That part is unsurprising, because just over 59% of the time, the shots wound up losing money, and the shot taker never had a chance to catch up.

The range of the shot taker was the widest, though. The worst case scenario saw this person with a net worth of $70.3k, but the best case scenario saw this person end up with $38.1 million, due to the rare cases where there were 3 or more successes (approximately 1 in 1000 times).

The shot taker failed to get to the target number slightly more than the conservative investor.

The person who stopped if he had a successful swing at the fences had an insignificant difference in average net worth, again, slightly below $2 million, and $94 worse off than the consistent shot taker. The difference was in the median net worth. The stop if you get ahead person had a median net worth of $1.32 million, but was $5,300 better off than the continual shot taker. The best case of this person was worse, though, topping out at $37.6 million.

The success in reaching the target number was only fractionally better than the whole hog shot taker.

It’s hard to judge from the overall body of work whether or not it’s worth taking a crack. So, let’s look at what happens in the roughly 41% of the time when, according to the scenario I set forth, you take a crack in your late 20s and you hit something.

For the continual shot taker, both the average, at $2.55 million, and the median, at $1.63 million, were much higher.

He also hit the target number about 46% of the time.

The difference was in favor of the person who stopped taking shots once he was successful. The average net worth was $2.56 million and the median net worth was $1.64 million. The average net worth was approximately $4,000 more than the continual shot taker and the median was almost $6,600 more.

The biggest overall difference was in the ability to hit the target number by age 55. Taking shots was about 10% more likely to result in an “early retirement” than not taking shots.

Based on these simulations, it appears that taking shots when you’re young doesn’t have a dramatically negative impact on your overall net worth compared to not taking shots. This is mainly because, relative to what your net worth will be when you’re much older, your net worth is small. A ding won’t hurt that badly. Plus, as we’ve seen in “Sacred Cows Make Great Burgers,”, savings rate is more important than rate of return when it comes to meeting your retirement goals.

Taking a shot does seem to increase your chances of being able to retire early, albeit not by a wide margin, while not drastically impacting your overall ability to retire. While the chances aren’t great regardless of whether or not you take shots, they are slightly better if you do.

The bigger issue may be the psychological impacts of taking shots and not succeeding. As we’ve seen in “Why Past Performance Indicates Your Future Investing Actions,”, Monkey Brain will cause you to take bigger and bigger shots to try to make up for losses. If you’re not cognizant of how he likes to invest, you may go off the rails after a series of unsuccessful shots, taking more and more risk rather than simply ramping up the amount you invest and sticking with relatively conservative investments.

Should you take shots?

It depends on your goals. If you’re looking to retire early or amass a larger nest egg, then you’ll have to take some risks to get there. You could also increase your savings rate, but increasing your savings rate in your 20s probably won’t have the potential upside impact that hitting a ten bagger would.

If those aren’t your goals, or if you just don’t have the psychological makeup to deal with a series of losses (see “Six Reasons Why I am Not Naseem Nicholas Taleb and Neither Are You” for a further discussion of how much capital you need to continue to take losses in search of the home run), then taking a shot seems detrimental to hitting your overall goals. Most of the time, even after you take a series of shots, you won’t have anything to show for your efforts but a losing streak.

If you do want to take a shot, I recommend you stick to the 5% rule, while looking for something with a higher overall potential return.

Shots can work. I’m living proof that they do, and so is Sam, whose story I related in the beginning of this article. They can also be addictive. If your shots don’t succeed, which, statistically speaking, is the more likely outcome, you could convince yourself that it was bad luck, unaligned stars, or a government conspiracy rather than your own shortfalls in investing, and if you become convinced that you have the magic touch and it’ll eventually work out for you, you could find yourself sinking ever greater amounts of money trying to hit it big and make up for your past losses. Swing carefully and don’t keep swinging. Set limits and know when you’re going to quit and take the more conservative route.

Do you take a swing for the fences with your investments? Tell us about your experiences and how they’ve worked out in the comments below!

Published by

Jason Hull, CFP®, is the Managing Member of Broadtree Partners, a firm that acquires $1-5MM EBITDA companies.

8 replies on “Should I Take Shots With My Investments When I’m in My 20s?”

  1. Jason,

    Interesting analysis!

    I’d just add in a note that your S&P returns are nominal. If inflation averages 3% per year, that $2 million goal in mind for age 65 will only be worth a little more than $600k in today’s dollars for a 26 year old.

    1. Hi Wade – Thanks, as always, for commenting! I hope this side of the ocean is treating you well.

      I actually did include inflation in the model for determining probability of retirement success. That was included in determining the “retirement number,” which is a function of inflation, safe withdrawal rates, and anticipated elderly spending declines. But, yes, your point is well made – $2 million 40 years from now won’t buy what it does now unless we have a repeat of 1870 – 1890 times 2.

  2. Pretty fascinating analysis here Jason. It’s hard to make anything if there’s no shot at all.

    Instead of 5%, I allocate 10% of my net worth to swing for the fences. I’ve been chasing the crazy unicorn ever since 2000. The peak was $200K, and I sold at around $155K btw.

    I have a strong feeling that a lot of people are much wealthier than the public knows due to Stealth Wealth. For this reason I’m very bullish on our economy, which is also much stronger than what people think.

    Best,

    Sam

    1. Hey, Sam – Thanks for dropping by and commenting! I really enjoyed that article and hope my readers learned some wisdom from it.

      I think the well off are better off than people think, but I also believe that there is a gap between the well off and the not well off. Remember, we’re in the personal finance community; there is a self-selection bias going on.

      I share your sentiments about the economy, though. Heck, just getting the poor in Asia and Africa into the middle class would be an almost unimaginable economic boost.

  3. You keep coming up with really interesting scenarios, Jason. I love the concept, though despite any analysis you put out there I am simply not a shot taker. I am the short Filippino version of John Stockton, passing the ball to others (my 500 teammates in Team S&P?) and letting them take the shots.

    1. Maybe you’re married to Karl Malone?

      There are many ways to skin the cat. The most common one for people who want to retire early, like you, is save like crazy. Save enough, and rate of return’s relative importance in the probability of getting to your goal vastly diminishes. Few people are willing to make those decisions; I know I didn’t throughout most of my 20s.

  4. I’m still confused about the behavioral-psychology logic behind taking shots with excess money which will generate even more excess money. I guess the whole idea is to self-insure for long-term care expenses or eventually make my heiress very happy.

    The best I’ve been able to do is to limit this “testosterone poisoned investing” to about 10% of my portfolio.

    1. If you’re in your 20s and already have excess money that will generate excess money, then you’re doing quite well for yourself!

      Having a separate fund to pay for long term care expenses out of pocket isn’t the worst thing in the world. If you don’t need to pay them, then your heiress will benefit.

      My 5% rule is simply a rule of thumb, even though I’m not generally a fan of rules of thumb. YMMV.

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