From concerns over global markets, politics and bubbles to worries about inflation, taxes and fees, there are many things on investors’ minds today. But, in actuality, investors have nearly complete control over the two most significant drivers determining their lifetime investing outcomes:
- Spending less than they earn.
- Committing to more equity exposure.
The degree to which individuals save (as a percentage of their income) and the degree to which they commit to owning equities (as a percentage of their portfolio) are directly related to their financial success. If investors get these two things right, almost nothing else will matter. And if they get them wrong, focusing on those other concerns won’t help at all.
Of course, what is appropriate for each person is based on his or her goals, capacity for saving and risk tolerance. It’s also important to understand the tradeoffs: Saving more means deferring gratification and staying more invested in equities means welcoming volatility.
In the context of a personal financial plan, people have a variety of goals, including educating children, saving for major purchases, caring for aging parents, maintaining a certain lifestyle in retirement or leaving money to family or charity. The higher their savings rate and the greater their exposure to equities, the more likely they are to achieve these goals.
But some people cannot save 10% or more of their income and some cannot save anything at all. Others cannot commit to owning equities because they know they cannot endure market volatility without altering course. While it’s possible to trade between these two major areas — saving more if one cannot tolerate volatility and vice versa — those who can do both will almost inevitably see the best results.
Of course, the benefits of more savings and more equity exposure come with a cost. Like everything in personal finance, they involve tradeoffs. In order to save more, you must spend less. This could mean a less extensive cable package, a less fancy car, fewer dinners out, a less expensive bottle of wine, public school for the kids, camping instead of trips to Hawaii and the like.
Deferring gratification means missing out on something today, but there’s a very strong psychological pull to spend now. “Live for today, tomorrow may never come,” the saying goes. Future potential gratification simply doesn’t have as much power over us. But remember, it is still a choice and because of compound interest, you increase both your future potential gratification and your total lifetime gratification by holding back today.
On the other hand, if you maintain a higher percentage of your invested assets in equities, you pay the cost in stomach-churning volatility. But don’t confuse this volatility with risk. It only becomes increased “risk” when you act on it (buying high and selling low). Historically, patience wins the day, and that means riding out the ebbs and flows inherent in the market.
That said, it’s critical to understand how much volatility you can stand. If you cannot stomach much, you will have to save more and spend even less today. If you can seriously commit to more equities (and the increased volatility that comes with that choice), you may be able to spend more today.
Beyond these two crucial issues, everything else – including timing, investment product selections, choosing active vs. passive investments, employing complex investing strategies or whether you work with an advisor – amounts to rounding error. So save more, hold a broadly diversified basket of as many equities as you can stomach and be patient. Be disciplined and believe in your plan. Then go read a book. Or, write one if it suits you.
Originally published on nasdaq.com.