“It takes money to make money,” or so the saying goes. In lottery states, the advertising often sounds like this: “You can’t win if you don’t play.”
Both are common-sense statements, and both are horribly wrong when it comes to retirement investing. It’s truly important to understand just how much risk matters when it comes to long-term investing, and how reducing risk is the key — not raising it.
Consider for a moment the lottery come-on. Sure, you can’t win if you don’t buy a ticket. But that ticket, as you are surely fully aware, represents an incredibly tiny chance of winning, virtually zero.
Investing is not the lottery. It’s not even gambling. Real investing is putting your money to work in corporations via stocks and bonds. It’s lending to governments. Both activities, represented by securities, imply a return of your money and something extra.
The risk comes in when you overload your portfolio with unproven companies and untrustworthy institutions. A broadly diversified portfolio greatly reduces that risk, leaving behind only the reward of investing, in the form of returns.
So, yes, you cannot “win” without actually investing but, unlike the lottery, you are very likely to come out ahead. Especially if you stay in the market for the long run, collecting those returns decade after decade and reinvesting along the way,
As for the business dictum that it takes money to make money, this is also true about investing, at least at first. You do have to save and you do have to invest to get those gains.
Yet, over time, your gains and interest payments begin to work for you. Money enters your account automatically, especially if you periodically rebalance your accounts.
Rebalancing is nothing more than selling high and buying low, over and over, programmatically. If you own a portfolio with a variety of asset classes, eventually they begin to diverge in valuation. Stocks may run higher relative to bonds. International equities may fall relative to U.S. stocks. Real estate could become suddenly cheap.
The important decision is to take action, selling off some of the higher-value positions and using the cash to buy the cheaper ones. It’s counterintuitive but effective. One study by Princeton Professor Burton Malkiel, author of A Random Walk Down Wall Street, showed that just by rebalancing investors saw a 1.5% edge over the stock market return.
So yes, it takes money to make money, but rebalancing is free money generated inside your own portfolio, over and over, like a natural resource. The end result is a higher, risk-adjusted return.
Combined with compounding and regular saving, just these simple disciplines will result in steady, solid growth in your retirement savings with few surprises along the way. No lottery ticket needed.