A Key Factor For Financial Success
As an investment professional I spend a huge part of my time helping clients to develop investment strategies and to identify specific investments that balance the need for growth with the need for asset preservation. And over time, the value of these efforts pays off by maximizing the likelihood of their being able to live the life that they want. But investment performance is only one contributor to financial success. You also need to save. Your ability to judiciously and consistently add to your investment portfolio throughout your working years will do as much good, especially for your post-retirement years, as anything else.
Suppose we have two 42-year old investors who have amassed $500,000 in savings. John, whose $500,000 investment portfolio is largely based on an inheritance, spends all the money he earns rather than adding any of it to his portfolio, while Mary is focused on saving as much as she can, maximizing her 401(k) contributions (we’ll assume that’s $18,000 per year) until she retires. Assume they both get a 5% average annual return on their investments. Ignoring taxes, John’s portfolio will grow to a little over $1.5 million by the time he turns age 65. Mary will accumulate nearly $2.8 million over the same period. That’s almost 50% higher following the same investment strategy. Imagine how much more Mary would be able to spend throughout her retirement years.
What would it take for John to amass the same amount in retirement as Mary without changing his saving habits? He’d need to get a higher return on his investments, specifically over 6.8% each year. Although that difference may not seem like much, that extra 1.8% each year is a lot harder to achieve and entails more risk. If there were a significant market downturn during the year these two investors retire, it would have a much more deleterious effect on John’s retirement goals than on Mary’s.
I’m not suggesting that everyone should scrimp while they’re working in order to save as much as possible for their future. You can determine the right balance between saving and spending by creating a goal-based financial/retirement plan. Such a plan will help you identify and prioritize what’s most important to you, both now and in your future, and consequently tell you the right way to save and invest for your particular lifestyle.
Once you know how much you should be saving, is there a best way to achieve it? I wrote previously about what is called burst savings, the idea of saving rather than spending unplanned income such as company bonuses (see https://www.cognizantwealth.com/2012/09/17/a-different-way-to-save-for-retirement/). That certainly works, but in order to meet your future goals, you need planned sources of savings as well. Recent research by the Employee Benefit Research Institute (EBRI) found that those 401(k) plan accounts with the highest balances were those whose owners contributed regularly rather than those who contributed spottily or who occasionally withdrew money. That seems obvious if you think about it, but the conclusion is that saving even small amounts regularly and consistently will yield better results than saving only occasionally. In other words, creating a habit of saving is one of the most effective ways of doing it.
The EBRI study also noted that no one appeared to outperform by jumping in and out of the market, trying to time the highs and lows. Even those accounts that remained invested during 2008 with consistent contributions bounced back quickly.
If you have a 401(k) plan at work, it pays to take advantage of any automatic enrollment, automatic pre-tax contributions, and automatic escalation of contributions each year. If you don’t, you can simulate that strategy with automatic contributions to an IRA or Roth. Saving is a necessary component for your future-self’s financial success, and consistency has been shown to make a positive difference.