We all have long-term goals, many of which require money. Maybe you’d like to pay for your child’s education. Maybe you want to save up for a down payment on a house. You almost certainly would like to retire someday.
With any of these long-term financial goals, the chances are high that you’re not doing them exactly as they’re scripted in the textbooks: starting at age X, finishing at age Y with Z dollars accumulated. Perhaps you’re starting late and you need to catch up. Or maybe you’re starting early and would like to hit your goal sooner. Whatever your particular circumstance, there is often a desire to find a way to make your money grow faster so that you can meet your goal along the timeline that fits your needs.
So what’s the best way to do it? Well, I ran I little experiment comparing two options: investing better and earning more. Let’s find out which one is more effective.
More effective than what?
Before we evaluate the different ways to grow your money faster, we have to define the baseline. In other words, where are we starting from that we want to improve upon.
The first baseline is the regular contribution you’re currently making towards your goal. For example, you’re probably contributing a certain amount of money towards retirement every year. This number will be different for everyone.
The second baseline is the return you can earn on your investments with little effort. For an example of how you can invest very effectively with little effort, read this: How to beat 80% of investors with 1% of the effort. For simplicity’s sake, we’ll assume that you can earn 8% per year with an index fund tracking the US stock market.
So the baseline is your current contribution earning an 8% rate of return.
Setting up the experiment
To beat this baseline, you will have to either contribute more money or earn a higher rate of return. Assuming you’re already living by a budget that’s tailored to your current income and needs, you won’t have much room to cut spending in order to increase contributions. That leaves you with two choices:
1. Earning more, in order to increase contributions, or
2. Investing better, in order to increase returns
To test the two options against each other, I decided to create a spreadsheet and run some cold, hard numbers. You can see the spreadsheet and play with the numbers yourself here: Earning More vs. Investing Better.
Before getting into the results, let’s take a look at the variables I included:
Baseline Annual Contribution: The annual amount you will contribute, before earning any extra money.
Baseline Return: The investment return you could earn with a completely passive investment strategy, such as the one advocated here: How to beat 80% of investors with 1% of the effort.
Better Return: The investment return you could earn if you were to devote your extra time to beating the markets.
Weekly Hours Investing Better: The number of hours per week it would take you to earn that extra return on your investments.
Hourly Rate for Earning More: The hourly rate you could earn if you instead spent that extra time working.
For the default example in the spreadsheet, I assume that you could beat the market by 2% every single year. I also assume that it would take 20 hours per week devoted to investment research in order to do so.
Finally, I assume a $10 hourly rate if you instead spent that time working for additional income, and that all of that extra income is dumped into your investments at the beginning of the each year (except for the first one, since you haven’t worked that extra time yet).
I did not attempt to take taxes into account on either the investing or earning side.
So which is more effective? Investing better or earning more?
The results ended up being pretty clear. Here is your ending balance in each scenario after 1, 5, 10, 20 and 30 years:
Clearly, it ends up pretty strongly in favor of earning more. Using these specific variables, you end up with almost 33% more money when you spend your time earning more money rather than trying to invest better and beat the market. You can spend some time playing with the variables yourself, but almost any realistic numbers I plugged in came to a similar conclusion.
How do you use this information to spend your time productively?
Clearly, these numbers alone argue strongly for the course of using a simple investment strategy and spending your extra time working on increasing your income. The simple math says that even if you ignore all other factors, this is the best route for speeding up the growth of your money.
But I don’t want to ignore the other factors. I think there are some additional reasons to focus far more on the earning more side of things than investing better.
Increasing earnings is more likely
While I’m not going to pretend that it’s easy to start earning more money, it’s certainly much more likely to happen than increasing your investment returns.
In the example here, I assumed only a $10 per hour wage. Many people could earn close to this simply by negotiating a raise, without any extra hours put in. There is also the opportunity to find some part-time work. Entrepreneurial types might try to build up an income-producing side business. Each of these things might take some time before they pay off, but they’re very doable.
On the other hand, beating the market with your investments is very unlikely. Even the majority of professionals, who dedicate their entire professional careers to earning superior investment returns, fail to do so. A recent study actually found that a simple index-oriented strategy like the one in our baseline above beat active investors (those trying to beat the market) over 80% of the time. And even when the active investors did win, it was by an average of only 0.52%. So the 2% out-performance we assumed in our example was extremely generous and therefore extremely unlikely.
Increasing earnings is more consistent
If you’re able to increase your earnings, the likelihood of those earnings staying consistent is pretty high. Think about your job now. Sure, there’s always the chance that you might lose, but by and large you earn the same paycheck month after month. There isn’t much variability and there isn’t a big chance that you would lose those extra earnings unless you chose to do so.
With investing, it’s almost exactly the opposite. First of all, no matter how good you are your returns will vary dramatically from year to year. That’s simply a function of investing in the markets at all. No one has only positive years with no negative years, especially if they’re trying to outperform the market.
But even more importantly, the same research above showing that very few investors are successful at beating the market also shows that the ones that do over one period are very unlikely to do so again over the next period. That is, very very few investors consistently beat the market over many years. So even if they actually could beat the market by 2% over a few years, it’s very unlikely that they could sustain it over the 30-year period used in our example.
The bottom line is that once you increase your earnings, you’re likely to sustain that increase. An increase in investment return is likely to be temporary, if at all.
If you want to speed up the growth of your investments, the best way to do so is to increase the amount of money you earn and put it into your investments.
Follow-up: If you’d some guidance on how to create a “good enough” investment plan for the money you’re saving, check out my book: Smart Investing for Your 20s and 30s.