The concept of “investing success,” as it often appears in the media, is a tangled web to me. Every time I read something about the topic, I can’t help but feel that the authors are confusing two very different efforts: investment success and investor success.
Yes, this is nuanced, but yes, it matters. Too often, investment success is defined in either absolute or relative returns (which is another nuance for another time). While I understand why a portfolio manager would focus on higher returns, I’d argue that this shouldn’t be the benchmark for success for the typical investor. Instead, they should be focused on building the wealth they need to fulfill the objectives that matter most to them. Wealth is measured in dollars, not percents.
Your Savings Rate Is a Huge Factor in Your Success as an Investor
Sure, better returns build more wealth faster, but higher returns are not essential to building wealth. Investing is a partnership between an investor and the markets, where an investor provides the capital and the markets provide the prospects for a return on that capital. Understanding this relationship introduces a most important point for building wealth — capital contributions.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
A portfolio’s value can grow through both capital contributions and the return on capital, but only one part of this equation can grow wealth reliably: our capital contributions, or more generally, our savings. It’s our contribution to our own investment success and importantly, unlike the investment returns we seek, its benefits are both more certain and within our control.
Contributing More to Savings vs. Taking More Risk
As illustrated in the figure below, moving from a more conservative asset allocation (50% stocks/50% bonds) to a more aggressive one (80% stocks/20% bonds) tends to widen the range of expected outcomes. At any asset allocation choice, higher savings levels contribute to higher best, worst, and median expected outcomes, due to the higher levels of capital contributions.
What is often overlooked, however, is that higher levels of capital contributions allow investors to improve their expected outcomes not only relative to the same asset allocation, but also relative to a higher risk allocation. For example, for the 50% stocks/50% bonds portfolio, a 6% contribution rate provides a better range of total potential outcomes than a 4% savings rate for the same asset allocation and for the majority of expected outcomes in even riskier allocations.
Higher returns are welcomed, but they are a less reliable source of asset growth and wealth creation.
A most extreme version of this scenario played itself out on the national stage when the Powerball lottery offered a $1 billion-plus jackpot. While the lottery gave a player a chance for a fabulous return on their $2 ticket, probability-wise, a player’s wealth would increase more certainly if they didn’t play the lottery at all (since they’re most likely to lose their whole “investment” in lottery tickets).
The Bottom Line for Investors
Investing involves tradeoffs, and an important part of the financial planning process is for an investor to define their willingness to forgo spending now to improve their prospects for building wealth that can provide for their future needs. This is critically important, as a higher savings rate provides a higher probability of investor success. This is due to the partial shift in responsibility for building wealth from the less certain returns from risky assets to a more certain stream of capital contributions.
In the end, if an investor is trying to maximize future wealth, we believe a marginally higher savings rate, rather than a substantially higher risk portfolio, will be more likely to lead to investor success.
-
Four Spa Retreats for Well-Heeled RetireesWe hand-picked these U.S. spa retreats for their serenity, amenities and dedication to the comfort of older travelers. All are located in the Continental U.S.
-
Four Military Benefits That Have Helped My FamilyMilitary life can be challenging for servicemembers and their families, but they're offered some significant financial benefits to help cushion the blow.
-
Why More Americans Are Redefining Retirement, Just Like I DidRetirement readiness requires more than just money. You have a lot of decisions to make about what kind of life you want to live and how to make it happen.
-
A Compelling Case for Why Property Investing Reigns Supreme, From a Real Estate Investing ProInvestment data show real estate's superior risk-adjusted returns and unprecedented tax advantages through strategies like 1031 exchanges and opportunity zones.
-
Are You Retired? Here's How to Drop the Guilt and Spend Your Nest EggTransitioning from a lifetime of diligent saving to enjoying your wealth in retirement tends to be riddled with guilt, but it doesn't have to be that way.
-
Government Shutdown Freezes National Flood Insurance Program: What Homeowners and Buyers Need to KnowFEMA's National Flood Insurance Program is unavailable for new customers, increased coverage or renewals during the government shutdown.
-
Separating the Pros From the Pretenders: This Is How to Tell if You Have a Great AdviserDo you leave meetings with your financial adviser feeling as though you've been bulldozed into decisions or you're unsure of what you're paying for?
-
Five Downsides of Dividend Investing for Retirees, From a Financial PlannerCan you rely on dividend-paying stocks for retirement income? You'd have to be extremely wealthy — and even then, the downsides could be considerable.
-
I'm a CPA: Control These Three Levers to Keep Your Retirement on TrackThink of investing in terms of time, savings and risk. By carefully monitoring all three, you'll keep your retirement plans heading in the right direction.
-
Debunking Three Myths About Defined Outcome ETFs (aka Buffered ETFs)Defined outcome ETFs offer a middle ground between traditional equity and fixed-income investments, helping provide downside protection and upside participation.
