Sometimes I feel like a broken record, but people do and say things like a broken record that make me feel like I need to keep pushing the point. In this instance I am talking about seeking the best investment returns.
Too many people are spending untold hours trying to select the ‘perfect’ funds. Looking for the next big thing or trend so they can achieve great returns. Yet, the same person will often be wasting a lot of money unnecessarily on their budget. If some people spent as much time on their spending as they do on their investment returns they could be much better off.
But they don’t. That’s because it is harder. It’s harder to accept responsibility. It’s easier to ‘hope’ for better returns than it is to actually do something about it that we can control.
We all know how hard it is to outperform the market. But a lot of us continue to try by trying to time our investments or selecting certain niche funds.
Let’s assume that with all the extra effort you are able to achieve better returns of 1%. 6% vs 5%. If you invest $10,000 a year for 10 years, that is a difference of about $8,000. Not bad. But not great either. You are taking on a lot of extra risk for that extra per cent. You could just as easily be down $8,000.
Instead you could achieve the same returns by investing an extra $750 per year for 10 years. That is just $63 a month. On an in the hand income of $50,000, that is an increase in savings rate of just 1.5%.
In my opinion that is pretty small fry stuff. Small effort for large impact and much better than chasing alpha (higher returns) in my opinion. This way is more of a guarantee. In personal finance, behaviours mean everything.
To further illustrate the importance of your own behaviours and an increase in savings rate we will use another example. Kylie and Danni are fresh out of University and have both recently started their first full time jobs. Can you believe it, but they are on the exact same pay and both ready to start saving on the same date. You’re not going to believe this, but they’re also the exact same age. They are 25 and earning $50,000 in the hand. They both earn annual raises of 3% and both decide to invest in the exact same index funds earning an in the hand return of 6% per year.
There is just one key difference between the two. Kylie saves 15% of her income, whereas Danni saves 5%. So what happens over a 40 year working career?
The impact of a higher savings rate over 40 years
After 40 years, Danni has $666,000 in the hand, and Kylie has almost $2 million. Even if we did increase Danni’s returns to 7%, 1% more than Kylie, she would still just have $846,000. She would need to achieve returns of 10.5% to match Kylie’s returns. Almost twice as much in returns as Kylie!
Changing spending and saving behaviours are hard. That is why so many focus on trying to achieve outsized returns. Investment returns are sexy. Diligently saving and investing are not. But the reality is, the savings rate variable has so much more of an impact on your financial future. And as a bonus, it is completely within your control.
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The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here