Technology stocks are rarely associated with retirement plans. Retirement stocks are thought to be businesses with stability, predictable profits, and returning cash to shareholders in the form of dividends for income. By contrast, tech stocks are often seen as unpredictable cash-burning gambles.
As a younger investor, I was tempted to focus on simply playing it safe -- or at least what I perceived to be safe. That was until I discovered one simple principle that changed my entire perspective.
Playing it safe could cost you
I'll share the principle momentarily. But first, I'll point out that, for retirement accounts, many investors prioritize making money over beating the average return of the stock market. However, this focus can lead to questionable investing decisions.
Three companies often regarded as great retirement stocks are The JM Smucker Company, Kellogg, and Campbell Soup. All three have been in business for more than a century, pay a dividend with a better-than-average return (dividend yield), and for those who bought 10 years ago, these stocks have never been down more than 10% at any point, as the chart shows.
The problem is, the chart also shows that they're giving investors below-average returns. Therefore, by picking safe stocks, investors always marched higher, which is good. But they sacrificed precious upside.
For investors who only wanted positive returns and a good-paying dividend, they could have elected to invest in something like the Invesco S&P 500 Equal Weight Consumer Staples ETF. This product holds positions in many stable companies (including JM Smucker, Kellogg, and Campbell), pays quarterly distributions to fund holders, and has also maintained positive returns for more than a decade as well.
The advantage of the Invesco S&P 500 Equal Weight Consumer Staples ETF -- and many exchange-traded funds (ETFs) for that matter -- is that returns are much closer to the average of the S&P 500.
Therefore, if your goal is to inch your way toward retirement without ever backtracking, investing in ETFs is probably the smartest choice to make. Certain ETFs can provide the safety you crave without sacrificing average upside.
A principle to challenge investing assumptions
Investing in ETFs can seem smart. And indeed, for many investors, it could be an important part of their overall investment strategy. But in this article, I want you to understand how important the Pareto Principle is.
The Pareto Principle basically says that 20% of inputs control 80% of outputs. And it's a principle Berkshire Hathaway Vice Chairman Charlie Munger agrees with, at least loosely. Berkshire has produced astronomical returns for shareholders. But as Munger once said, "If you took our top 15 decisions out, we'd have a pretty average record."
In other words, a small 15 inputs accounted for the majority of Berkshire's outperformance -- the Pareto Principle at work.
The younger you are, the more you might consider approaching your journey toward retirement with this principle in mind.
Let's take three tech companies as examples: Microsoft, Apple, and Nvidia (NVDA 3.65%). Let's suppose that 10 years ago, a 30-year-old investor put $10,000 in each of these companies. That would have been a phenomenal decision, fast-tracking their path to early retirement.
That $30,000 total investment would be worth about $743,000 today. And at age 40, they'd be well on their way toward retirement.
Perhaps you accuse me of cherry-picking these tech stock examples. Well, I'm guilty as charged, because that's the point. There are few companies that have returned as much over the past 10 years as cherry-picked Microsoft, Apple, and Nvidia. They were three of the small Pareto Principle inputs that drove the majority of returns.
Once understood, this principle can change a person's entire investment philosophy. However, there are inherent drawbacks with investing this way.
For starters, you'll probably pick many bad stocks. Moreover, your portfolio may underperform the market for periods of time.
The approach has inherent problems. But that's why the Motley Fool investing philosophy takes this into account and includes this tenant: Invest new money regularly.
Did you pick a bad stock? No problem. Try again with new money next time. This increases your chances of finding the next Nvidia.
The Motley Fool also recommends holding winning investments for a long time -- not selling quickly to "lock in gains." Imagine repeatedly failing with stock picks, finally stumbling upon Nvidia in 2012, and then selling it after it went up 100%. Locking in gains would have locked you out of a life-changing retirement nest egg.
If you're young and want to retire early, you'll probably need to score a few market-beating investments. Indeed, market-beating stocks will obviously get you to the finish line faster than average or below-average returns. Those market-beating stocks could come from the tech sector. But they could come from other sectors as well.
However, for the strategy to work, you need to become comfortable with a different investing mindset that embraces being wrong often and remains nevertheless resolute in being an investor for the long haul.
