Yesterday’s post described how it is possible to get superior returns by active value investing. Now, before anyone decides to become an active investor, there are some things to consider first.
Value or any kind of active investing takes time. There are, therefore, opportunity costs to consider.
Suppose you have $10,000 to invest and that your efforts are worth 2% extra return (alpha). First of all, you might not directly see those returns immediately. It might take a decade (a market cycle to be more exact) to verify that you are actually generating alpha on a consistent basis. More importantly, though, 2% on $10k is $200. If you spent 20 hours analyzing companies to make those $200, that is $10/hour. Many part time jobs pay better than that and therefore you would probably have been better off with a passive form of investing while taking on a second job.
If on the other hand, you had $100,000, the same effort results in an hourly compensation of $100. In other words, unlike a salary where you work unrelated to an asset, your compensation as an active investor is directly proportional to the size of your asset base.
I do not think that a low hourly wage should deter anyone from doing anything (unless your desire is to end up with as much money as possible in which case I’m kinda surprised that you still read this blog). There is significant satisfaction in doing things yourself and taking full control. What difference? It’s the difference between living in a house and living in a house you built yourself. If this difference does not mean anything to you, then unless you have six-figure assets, you are probably better off financially taking a second job as a sign-spinner(*) and investing everything in index funds.
(*) In case you don’t know what a sign spinner does (I didn’t before I moved to CA), it is a job that requires no other qualifications (they point this out in the job ads) than the ability to stand for 3-4 hours at intersections and hold/twirl a sign pointing drivers to furniture sales, real estate, etc. Around here, the compensation is $10/hour + free sun tan and you can talk on your handsfree headset while you do it.