I’ve written a lot about why people shouldn’t spend a huge portion of their time focused on investing. This isn’t to say you shouldn’t focus on building wealth, it’s that you shouldn’t focus a ton of your effort on researching tons of stocks or bonds to invest in, trying to squeak out a marginally increased return on your investments.
But why not? Why shouldn’t you focus on getting higher returns? And if not, where should you direct your efforts?
Today, we’re going to dive right into that.
WHY FOCUSING ON INVESTING ISN’T A GOOD IDEA
In an article I wrote a little way back, I discussed why I think it’s a better idea for most people to use passive investing.
You should read that article if you have time, but if not, here are the main points:
1 – A very small percentage of active managers actually beat their benchmarks and outperform their targets.
2 – Of those managers that do outperform, only a few do on a consistent basis. Meaning this year’s winners will likely be next year’s losers.
3 – Human beings are irrational, and tend to make poor decisions at inopportune times. As this relates to investing – you are more likely to put money into the stock-market and take it out at the wrong times.
4 – Do you really want to be spending your time researching investments? Some people will enjoy it, but many of the clients and people I speak with don’t have that passion. So, it is more of a burden than anything.
WHY YOU SHOULD FOCUS ON SAVINGS
The next question then becomes “If not investing, where should I focus my efforts?”
In the early part of one’s career and wealth-building, the best place to focus your efforts is on your savings rate.
You: Uh-Oh! So, you’re telling me I can’t magically use investing to make up for my lack of savings?
Me: Nope! It isn’t likely!
The numbers show that in the early phase, savings rate plays a much larger role in your overall success than investment returns.
3 SCENARIOS TO CONSIDER:
Let’s say you and two friends are all earning a $100,000/year income.
Each year you commit to saving and investing 10% of your income – so, $10,000.
You take that money and invest it, and over the course of the year it earns a 10% return.
At the end of the year you now have $11,000 in your investment account. (That’s the original $10,000 + $1,000 in investment return)
Not too shabby. Anyone in in personal finance will tell you that earning a 10% return in a given year is a pretty solid year for the stock-market.
A friend of yours is doing the same exact thing, except they believe that if they spend a good amount of time researching better investments, they could increase their return numbers and get it up to 11%!
They are successful in this, and at the end of the year they earned $1,100 instead of the $1,000 that you received.
Now, for the final friend.
They believe in the power of passive investing, and are fine with the stock-markets return of 10% in any given year. However, they are very focused on increasing their savings rate and decide to save an additional 1% each year.
Instead of just saving $10,000/year, they have increased that savings rate up to $11,000/year. And if they earn the same 10% return on their investments that you did, they will end up with a return of $1,100, and a total account worth $12,100.
They didn’t have to do any work researching investments, and still came out ahead of the first two individuals!
Why? Because in the earlier years, by saving more you are able to have a larger impact on the size of your investment accounts.
IS IT ALWAYS LIKE THIS?
As you move along your wealth-building journey, the tides do change.
In later years, it becomes more important to make sure you are protecting your investment accounts from large losses. So, in this phase, you want to be more cognizant of the investment side.
However, this can be accomplished by changing the make-up of your portfolio, not spending tons of time researching different stocks. In essence, you can just become more conservative, which will help protect you from massive losses.
But your savings rate will always play an important role if you are earning an income.
The key point in this isn’t just about investing versus savings, it’s about understanding the value of looking at things from a different perspective.
In the scenarios outlined above, we saw that by increasing your initial savings rate you’ll end up well ahead of yourself even if you don’t get a higher investment return.
Long-story-short: It’s easy to get sucked into the sexy side of personal finance, which is investing, and forget that you have much more control of the outcome when you focus on other areas.