When you’re deciding what to invest in, there are two options: you can go for the “easy average”, or “earned outperformance”.
The easy average
The “easy average” is where you just buy a bit of everything in a particular market or asset class. By definition, you’ll then achieve the average performance of the set: you’ll have big winners, you’ll have big losers, but these will largely cancel each other out and the net result will be average.
This isn’t possible in every market: you can’t buy a bit of every residential property in a country, for example. The stock market is a great example of where you can: with a few clicks you can buy into a single fund that owns a piece of thousands of companies across the entire world.
What does “average” performance look like? In the global stock market, historically you’ve been looking at somewhere around 5-8% per year after stripping out inflation.
(This is an exceptionally rough range, which you could comfortably make a case for extending at both ends. Remember also that this is the average, so any given year could be virtually anything from +30% to -50%.)
If you’re happy with 5-8% per year, the “easy average” is a great way to go. It doesn’t require any effort, any time commitment, or any special knowledge. In fact, you’re explicitly admitting that you don’t have any special knowledge or the inclination to use it: if you did, you’d be trying to beat the average rather than accepting it.
What if you want to achieve better than that? There’s nothing you can do to improve the average, so you need to venture into “earned outperformance”. Rather than owning a bit of everything, you own very specific things that you believe will meet your performance targets.
Owning specific things, by definition, involves time, effort and special knowledge. You need to develop the knowledge, research various alternatives, then select your winners – all of which takes time and effort. Depending on what you buy, the asset might need active maintenance or monitoring. Your strategy might involve regularly selling assets and buying new ones, which takes even more time and effort.
The list of what you can invest in to achieve your earned outperformance is a long one:
- A selection of deliberately chosen shares/bonds, or share/bond funds
- One or more individual physical properties
- A large equity stake in an individual company, including your own
- Private lending
- Private equity
- Angel investing or venture capital
There are plenty more, too: that’s just what I came up with off the top of my head.
Where to turn for outperformance
So, which of these options should you choose to invest in?
You might think “the one with the highest potential return”. But actually, they’re all surprisingly similar:
- When it comes to investing in shares, it’s probably safe to assume you won’t out-perform Warren Buffet – and he’s averaged about 15% after inflation for the last 25-ish years. You might be able to beat 15% in an individual year, but not as an average over time.
- Investing in physical properties probably tops out at about 15%-20%, regardless of whether you’re holding for the long term or cycling in and out of deals.
- Private equity returns have averaged 15.3% over the last decade.
- Venture Capital funds target 20% as an acceptable minimum.
So assuming you’ll do a good job of picking your investments but you won’t be the best in the world, 15% is looking like a decent upper bound.
Choosing based on the return you can make isn’t going to work, then, because they’re all pretty similar. Instead, you could choose based on the characteristics of those returns (some are steadier year to year than others; some consist of regular cashflows while others are more lumpy), which would be a reasonable thing to do.
But my answer for what to invest in is whatever you’ll find consistently interesting and want to spend time on for years on end.
Why? Because remember: we’re talking about “earned outperformance”, which means you’ll need to develop specialist knowledge, and invest time and effort. If you don’t find it consistently interesting, you either won’t do it well or won’t do it at all.
So when people debate whether property is better than shares, whether the risks of private equity are worth it, whether you should own a business, and so on and so on, it’s missing the point. All investments can work equally well, and there’s only right or wrong for you.
Some people will never get tired of scrutinising companies’ financial statements. That’s great. Others can’t get enough of seeking out property deals and planning renovations. That’s great too. It just makes no sense to convince the person who enjoys one thing that they should actually be doing the other.
None of the above?
What if you’re not interested enough in any potential investment for you to give it time and focus over the long term? That doesn’t make you abnormal – in fact, it’s only a minority of people who are wired to care about this kind of thing.
If you’re just not interested, then I’d encourage you not to do it at all. Instead, take the “easy average” – and if you’re going to put your effort anywhere when it comes to improving your finances, put it into earning more or saving more instead.
After all, “earned outperformance” is going to earn you (when done well) roughly in the region of double what you could get by taking the average. So if you focus on earning twice as much and invest it in the average, you’ll end up in exactly the same place – in a way that’s more enjoyable and natural for you.