Are Long-Shot Investments Worth Your Time Or Money?

Matt Thalman - Contributor - ETFs

We all know the story of the tortoise and the hare and the conclusion that slow and steady wins the race. But regardless of us knowing the story and how it turns out, we still get caught up in the idea, or dream if you will, that we can get rich quick though the means of chasing long-shot investment opportunities.

We have all seen and heard of new investment opportunities that will make you rich; penny stock ideas that will show 1,000% returns, "the next big Initial Public Offering" that you have to own, or perhaps a friend, family member or colleague tells you about a great idea. We all wonder whether or not we should go ahead and pull the trigger on these "once in a lifetime opportunities" and if we made a huge mistake when we don’t.

Well let's look at some numbers, which will hopefully help make your decisions on whether or your time and money are best served chasing these dreams.

So let's say one of those "once in a lifetime opportunities comes by but you know there is only a 5% or 10% chance of it working out in your favor. But, because the odds of you making money are so low, the return could be from 500% up to 1,000%.

Now, in our example you get lucky (remember you only had a 5% to 10% chance of making money) and invested $1,000 in an investment that produced a return of 500% in one year, which means you just made $5,000 and now, have a total of $6,000. The other side of that coin is you decided not to invest in the risky opportunity and put your $1,000 in a very safe low-risk stock that returns you 5% over a year, meaning you made a measly $50. Instead of having $6,000 you only have $1,050.

Alright so $6,000 is not enough for you, so you begin searching for more high risk, high reward investments. Let's say you find 100 long-shot investments over the course of five years. You guess that 5% to 10% of them will pay off with returns of 500% to 1,000% on average.

Now we run some numbers; 5% or 5 of the once in a lifetime investments work at a 500% return. That means you would have made $25,000 on those five investments. Maybe those numbers are a little low and we say 10% of those investments returned 500% which would mean you make $50,000.

Not sure about you, but I am really liking these figures and how much money I can make!

Alright, let's go one step further and say 5% of your investments make you 1,000% return, netting you $50,000. Or what if 10% netted you 1,000% return getting you to $100,000. (Remember these figures are your net gain, so your real account balance would be the gain, plus the amount you invested in the profitable investments. In the example with 10% of your investments returning 1,000%, your total would actually be $110,000; the $100,000 return and the $10,000 from the 10 different $1,000 initial investments.)

Wow that’s great, you made $100,000! You're rich!

Well, maybe not rich. And honestly maybe that return isn't really even that good.

The original idea was that you would put $1,000 into an "investment of a lifetime", which really stands for a really, really, risky investment opportunity. The kind of investment that 90% to 95% of the time you are likely to lose money in, but have a slim chance of making you a really strong return on. In the above example you invested $100,000 total ($1,000 in 100 different investments) and in the best case scenario (10% of tour investments making an unheard of 1,000%) you ended up with $110,000.

If any of the other scenario's, only 5% of your investments made money or you only made 500% return, you actually lost money.

Now, let's say you take what I like to call the tortoise path to wealth. First, you focus on what the greatest investor of all time has said are his two rules to investing; rule #1 is don’t lose money and rule #2 is don’t ever forget rule #1.

So with those rules in mind, let's take our $100,000 and build a portfolio that will produce a 5% per year return. If the portfolio averages a 5% return per year, we will make $5,000 on our initial investment in year number one. After year number two, because of compounding results our 5% return on $105,000 would be $5,250, giving us a total of $110,250. (By my calculations the 5%, low-risk investment is already ahead of the high-risk investment by $250 after just two years.) If we run out the 5% return compounding each year for 5 years we end up with $127,628.15. That’s $17,628.15 more than you would make if you went with the long-shot investments and made 1,000% return on 10% of them.

So what can you own that is low risk but still give you a 5% a year return; well to start you could buy a few solid dividend paying stocks, like any of the dividend aristocrats that are yielding over or around 5% like AT&T (T) or Verizon (VZ). But if that’s what you are going to do, why not just pull the trigger of the ProShares S&P 500 Dividend Aristocrats ETF (PACF:NOBL). NOBL is my favorite dividend paying ETF, I have given my reasons in the past here, but the abbreviated version is that NOBL owns a portfolio of great companies who have a proven track record of returning cash to shareholders.

Another option would be simply going with a standard S&P 500 Index ETF such as the SPDR S&P 500 ETF (PACF:SPY). SPY has low costs, a good distribution yield, and gives you premium exposure to the market, with less risk than owning single stocks.

Or you could go a little riskier with a high dividend ETF like the PowerShares KBW High Dividend Yield Financial Portfolio ETF (NASDAQ:KBWD) or the even riskier emerging market dividend fund like the Wisdom Tree Emerging Markets Dividend Fund (BATS:DVEM).

Within the ETF world there are countless options that you can use to safely grow your portfolio by 5% a year, with limited downside risk. So remember the next time someone tells you "this is a deal of a lifetime" think about what that money could be used for and how the long-shot doesn’t usually pay-out.

Matt Thalman Contributor - ETFs
Follow me on Twitter @mthalman5513

Disclosure: This contributor did not hold positions in any company or fund mentioned above at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from for their opinion.

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