investing

Investor Success: Measure in Dollars, not (Per)Cents

You can’t control the markets, but a big part of your success in investing for retirement is entirely in your own hands.

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.

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.

Bar chart shows that conservative, moderate and aggressive portfolios do better with a higher contribution rate.

Courtesy of Don Bennyhoff

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. 

About the Author

Don Bennyhoff, CFA®

Investment Committee Chairman & Director of Investor Education, Portfolio Solutions

Don Bennyhoff, CFA®, serves as the Chairman of the Investment Committee and Director of Investor Education at Portfolio Solutions, a $1.6B RIA. An industry expert who spent over 22 years at The Vanguard Group, Don was a Founding Member of Vanguard’s Investment Strategy Group, and served as a Senior Investment Strategist.

Most Popular

Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021
7 Best Commodity Stocks to Play the Coming Boom
commodities

7 Best Commodity Stocks to Play the Coming Boom

These seven commodity stocks are poised to take advantage of a unique confluence of events. Just mind the volatility.
September 8, 2021
Stock Market Holidays in 2021
Markets

Stock Market Holidays in 2021

Is the stock market open today? Take a look at which days the NYSE, Nasdaq and bond markets take off in 2021.
September 2, 2021

Recommended

These 2 Emotional Biases Could Kill Your Retirement
Investor Psychology

These 2 Emotional Biases Could Kill Your Retirement

Are your emotions sabotaging your retirement plans? Some basic knowledge and careful introspection can go a long way toward avoiding major pitfalls.
September 20, 2021
Investment Strategies for the 4 Stages of the Economic Cycle
Markets

Investment Strategies for the 4 Stages of the Economic Cycle

The U.S. economy is cyclical in nature, surging ahead and pulling back in waves over time. Investors’ portfolios need to change with the rise and the …
September 19, 2021
How Exactly Do You Stress-Test Your Financial Plan?
retirement planning

How Exactly Do You Stress-Test Your Financial Plan?

Some tasks are not good for DIYers, and stress-testing your portfolio is probably one of them. Because individuals don’t have access to the same tools…
September 18, 2021
5 Charitable Surprises about High-Net-Worth Families
Charity

5 Charitable Surprises about High-Net-Worth Families

They might be out of the spotlight, but smaller family foundations are stepping up their giving in this time of need.
September 17, 2021