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.