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Savings Rate is More Important than Investment Return

Posted: 18 Sep 2017 02:05 AM PDT

Here's a piece from MarketWatch saying savings rate is more important than investment return. A summary of their thoughts:

The secret to building wealth has less to do with returns and more to do with your savings rate, according to analysts at Pension Partners.

In other words, the amount of money you contribute to your retirement fund is far more important than what investment vehicles the money is parked in, as you can control the former but not the latter.

It makes sense intuitively. Saving $20,000 a year will grow your wealth a lot faster than saving $10,000 a year. But even incremental savings-rate increases play a far bigger role than corresponding increases in the rate of return.

To illustrate the importance of savings vis-à-vis investing, Charlie Bilello, director of research at Pension Partners LLC, ran some numbers on what would happen to your wealth if you increased your savings rate by 1% and correspondingly what would happen if the rate of return on a portfolio increased by 1%.

Bilello assumed a median U.S. household income of $58,000, which after taxes leaves $49,300 to spend. Saving only 1% of this income every year for 30 years at a 10% return will lead to an accumulation of $81,096. That number is less than your wealth after saving 5.5% of income at a meager 1%, which would grow to $94.319.

Ok, let's review a bit:

  • There are three parts to the overall performance of an investment: the amount you save, how long you invest it for, and the return rate
  • Of these three, you can control two of them: how much you save and how long you invest.
  • The best way to maximize your investments is to let them compound over a long period of time
  • After that, the amount you invest is most important.
  • There's really very little you can do about return rate. IMO the best option for it is to simply invest in index funds. That way you'll beat 95%+ of the investors out there.
  • Even though it's the least important of the three, most people focus on return rate. It also dominates the financial media. Yes, it's the most exciting of the three (trying to beat everyone else), but it's way over-emphasized by the majority of people.

My best advice is to save as much as you can for as long as you can, putting what you save in index funds.

That's it.


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