What If?

By Brad Thomason, CPA


What if:

1. You earned the same amount of money from your job every year from the time you were 20 until the time you were 70, and…
2. You only spent half of what you earned every year, and saved the rest, and…
3. You lived in a world where there was no such thing as inflation

Would it ever be necessary for you to invest any money for retirement?

Arguably, it wouldn't.

In the above scenario you would essentially stockpile the equivalent of 50 more years of spending while paying for the 50 years of your working life.  Since, from age 70, you are almost assured to not live longer than another 50 years (at least based on what we know about aging and longevity, today) then you would have enough money to pay for your life without taking on any risk of loss from investing.

Now, obviously the world described above is not the one we are living in.  But the creation of the artificial conditions serves to focus attention on the very particular question of why we invest in the first place.

The implicit definition of investment that is being used here is something like 'letting someone else use your capital, in exchange for a fee, with the possibility that the capital might be lost.'

Why would a person expose themselves to such a risk if it were unnecessary?

If we change the parameters around and it becomes clear that the person won't be able to stockpile all of those future years of spending simply from the sum of savings alone, then it becomes obvious why the person would invest.  Without the addition of the investment earnings to the saved capital, there will be a shortfall in funding at some point in the future.  At least there will be if the person lives long enough.

So the reason for the risk in that situation is pretty obvious.

But what if that's not the case though?  What does that say about the logic of investing?

Keep in mind here, too, that the options are not a) be an investor, or b) put your money in the mattress.  The significant qualifier of the definition above is that the capital might be lost as a result of putting it to use.  So the person could take advantage of interest earning opportunities at banks or insurance companies, where there are legal guarantees, and the mandated financial infrastructure to back up those guarantees.  That wouldn't qualify as the type of investing being discussed here.  Even if such earnings don't do anything eye-popping with the account balances down through the years, they still serve to ward off some of the effects of inflation; the absence of which was the most unrealistic of the what-ifs listed above (FACT:  I know more than one business owner who lives on somewhere around a third of the annual take, saving the other two-thirds for later.  So the bit about saving a substantial portion of your yearly take-home was the least unrealistic of the what-ifs.  At least, relatively speaking). 

​If you succeed in amassing a large enough nest egg - most likely through the combination of saving and at-risk investing - you will awake one morning to find that you may not need to continue with your investing program any further.  You may have enough to carry the exercise (i.e. living) out as far as you'll need to.  When that day comes, you may find yourself asking just what it is that justifies the ongoing risk.  And if you think you are likely to ask such a question and have trouble answering it, then it makes sense to go ahead and spend some time thinking about the moves you will want to make, before that day actually arrives.