In a nutshell, that's my message for this month. It's directed to those who worry that we're headed for a Japanese-like economic meltdown. Or a resumption of the bear market. Or any of a number of events that would have an impact on the raw investment returns we can expect from our portfolios over the next few years.
Think about this with me for a moment. The amount of wealth we can accumulate through investing is determined by a great many factors:
The rate of return we earn. This is what we tend to concentrate on. Thus, the time we spend attempting to pick winning stocks, the hottest funds, or the most astute market forecaster. Unfortunately, unless we're willing to settle for guaranteed CD-like returns, this is the only factor in the group that's essentially out of our control. No matter how hard we study or how much we know, we can't predetermine exactly what our rate of return will be. So doesn't it make sense to turn more of our attention to the factors where we do have a lot of control? As in:
Whether we're building on a strong foundation. We don't have as much to fear from economic storms if we're debt-free, have an emergency reserve, and are living on a budget that produces a monthly surplus. Our ability to put such a foundation in place is affected by how big a house we buy, how new a car we drive, how responsibly we handle credit, and a host of other decisions -- all under our control.
How much we save. Invest $200 a month for 20 years at 10.0 percent and it will grow to $153,000. You could improve that to $216,000 by either (1) increasing your rate of return to 12.5 percent annually, or (2) adding a mere $1 to the amount you invest each month. Which do you think would be easier?
How much we lose to taxes. The above example assumes you're investing in a tax-deferred retirement account. If you made your $200 monthly investments into a regular taxable savings account, you'd need to earn a little more than 15 percent per year to reach even the lower $153,000 target (assuming a 34 percent combined federal/state rate). So be sure to make full use of tax-advantaged accounts like IRAs and 401(k)s.
How long we save. Compound growth examples show that amazing things happen when we leave money invested for long periods of time. That means we should start contributing to our IRAs and other investment accounts as early as possible and plan to leave the money working tax-deferred for as long as possible.
How much we invest in stocks versus bonds. Over the past half century, the average result from a 40 percent stocks/60 percent bonds portfolio invested for a 20-year period has been an 8.7 percent annual return. By changing the mix to 80 percent stocks/20 percent bonds, the average annual return climbed to 10.1 percent. Naturally, there were bear markets along the way when portfolios with heavier stock allocations did poorly, but for the period as a whole, stocks gave better returns than bonds to investors who stayed the course.
Whether we're playing the short-term trading game or the long-term investing game. In the investing game, you win by plotting your strategy very carefully at the outset, and then you let that strategy play out regardless of daily developments and news events. Current market fads and so-called "expert opinions" are largely irrelevant to long-term investors (see Make Sure Your Investment Decision-Making Is Inside-Out).
Whose advice we listen to. Is your strategy in sync with biblically-based financial truths, or is it more reflective of the "mythconceptions" we glean from the secular investing world? It's your choice.
These final seven factors are under our control. Focusing our energies on maximizing the effect they have on our portfolio's growth will contribute far more to our long-term success than our hit-and-miss efforts to raise our raw performance results.
