Focus on what you can control rather than worry about what you can’t. That’s one of the financial-planning takeaways from this month’s cover article.
It’s a timely reminder for investors as well, given the ever-present uncertainty about the stock market’s future direction. Some, like Vanguard, are saying 2016 will be kind to stocks — not sensational, but respectable single-digit returns. But you don’t have to go far to find many who disagree, pointing to what many see as high stock valuations at present as well as the Fed’s intention to begin raising interest rates.
There are any number of events that can affect the investment returns you can expect from your portfolio over the next few years. The amount of wealth you can accumulate through investing is determined by a great many factors.
- The Rate of Return You Earn
This is what investors tend to concentrate on. Thus, the time they spend attempting to pick winning stocks, the best funds, or the most astute market forecaster. Unfortunately, unless you’re willing to settle for guaranteed CD-like returns, this is the only factor in the group that’s largely out of your control. No matter how hard you study or how much you know, you can’t predetermine exactly what your rate of return will be. So doesn’t it make sense to turn your attention to the factors where you do have a lot of control? As in:
- Whether You’re Building on a Strong Foundation
You don’t have as much to fear from economic storms if you’re debt-free, have an emergency reserve, and live on a budget that produces a monthly surplus. Your ability to put such a foundation in place is affected by how big a house you buy, how new a car you drive, how responsibly you handle credit, and a host of other decisions — most under your direct control.
- How Much You Save
Invest $200 a month for 20 years at 10.0% and it will grow to $153,000. You could improve that to $216,000 by either (1) increasing your rate of return to 12.6% annually, or (2) increasing your deposit regularly by a mere $1 per month. Which do you think would be easier?
- How Much You 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% per year to reach even the lower $153,000 target (assuming a 34% combined federal/state rate). So be sure to make full use of tax-advantaged accounts like IRAs and 401(k)s.
- How Long You Save
Compound growth examples show that amazing things happen when you leave money invested for long periods of time. This means you should start contributing to your investment accounts as early as possible and plan to leave the money working tax-deferred for as long as possible.
- How Much You Invest in Stocks Versus Bonds
Fearing the next bear market, the temptation arises to dramatically cut back on risk. That makes sense for those nearing retirement, but not for those with longer time frames. Since before the Great Depression, the average result from a 40% stocks, 60% bonds portfolio invested for a 20-year period was a 9.2% annual return. By changing the mix to 60% stocks, 40% bonds, the average annual return climbed 1.6 percentage points to 10.8%. This includes the brutal bear markets of the 1930s, along with many others along the way when portfolios with heavier stock allocations did poorly. Over the long term, however, stocks give much better returns than bonds.
- Whether You’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 over a decade or more. The short-term news, current market fads, and so-called expert opinions are largely irrelevant to long-term investors.
- Whose Advice You Listen To
Is your strategy in sync with biblically based financial principles, or more reflective of the conventional thinking offered by the secular investing world? It’s your choice.
The final seven factors are under your control. Focusing your energies on maximizing their effect on portfolio growth will contribute far more to your success than hit-and-miss efforts to raise raw performance results.