One of SMI's old friends, Paul Merriman, recently wrote an interesting column for Marketwatch.com titled "How 1% can add $1 million to retirement." Its focus is on simple steps an ordinary investor can take to boost their portfolio's return — and providing the motivational kick in the pants to make those changes by illustrating how dramatic a difference that extra 1% per year can make.

Unlike most newsletters, we don't do a lot of "return baiting" here at SMI. But it's possible that in our reluctance to play the "Wouldn't it be exciting to earn this kind of money!?" card, we leave some motivational juice on the sideline that would, in fact, inspire readers to make positive changes to their spending and investing plans. So "today and today only!" I'm going to make an exception and blatantly tout some "You could earn this!" numbers for you.

(As a total aside, running these types of earnings scenarios on a financial calculator used to be one of my favorite pastimes back in college while enduring the drudgery of a particularly slow *cough-real estate-cough* class. That and dreaming of running a mutual fund someday. True story.)

Back to Merriman's column, here is how he introduces the "magic math of 1%":

If you invest $5,000 a year for 40 years and earn 8% annually, you'll (in theory at least) wind up with a nest egg of about $1.3 million. But if you earn 9% along the way, that nest egg grows to just under $1.7 million. The difference, roughly $400,000, is entirely the result of that extra 1% return.

Those returns are actually not far off from the returns of the market and Upgrading over the past decade. Through June 30, the Wilshire 5000 earned 8.28% annualized, while Upgrading earned 9.45%. If we substitute those returns into Paul's 40-year example, instead of the $394,000 difference he saw between earning 8% vs. 9%, we get a difference of $512,000. This just confirms the point of his article: Those small differences in return really do compound to big amounts over time!

But this, as they say, is just the tip of the proverbial iceberg.

What if someone had used a 50/50 blend of Upgrading and DAA instead? (Full disclosure — the DAA numbers used prior to January 2013 are back-tested, not actual.) If we plug the average of Upgrading and DAA's annualized returns from the past 10 years into Merriman's 40-year example, the numbers look like this:

Market 8.28% $1,394,635
Upgrading 9.45% $1,906,696
DAA/Upgrading 11.41% $3,257,223

 

Got your attention yet? Let's add a 10% allocation to Sector Rotation, as we did in Higher Returns With Less Risk: The Best Combinations of SMI's Most Popular Strategies. Using SR's return over the past 10 years, that bumps our total portfolio's return up to 12.05% and the results look like this:

Market 8.28% $1,394,635
Upgrading 9.45% $1,906,696
50% Upgrading/50% DAA 11.41% $3,257,223
40% Upgrading/50% DAA/10% SR 12.05% $3,889,093

 

I can already hear the skeptic's question: is it realistic to use the returns from just the past 10 years in a 40-year example like this? It's a fair question, to be sure, since none of us has any idea what returns will be for the market or any of these strategies in the future.

That said, longer time periods would only have benefited the annualized returns of each strategy. Pushing Upgrading out to 15 years from 10 years boosts its annualized return from 9.45% to 9.64%. Our cover article introducing DAA in January 2013 showed a 30-year annualized return for that strategy of 13.6% (which last year's 16.2% return would only have boosted). And Sector Rotation has earned a jaw-dropping 23%+ annualized return in our testing of it back to 1990, which is significantly better than the 15.81% (10-year return) I used in the illustration above.

In fact, if we go back to that Higher Returns With Less Risk article, we find that the actual annualized return from a 60/40 Upgrading + 50% DAA + 10% SR portfolio over the past 15 years was 12.9%. Anyone want to see what that return does to our 40-year example?

15 Yr: 40% Upgrading/50% DAA/10% SR 12.9% $4,928,741

 

These types of illustrations are fun, although they're probably more useful when the variable is the amount saved — which you control directly — rather than the rates of return, which you don't. We could really have some fun adjusting the saving number up from $5,000 per year, given that I'll bet many of you are hitting much higher figures (especially if company retirement-plan matching is considered).

Still, hopefully this illustration drives home the value of putting in the extra effort of implementing and maintaining these strategies. These returns aren't one-off stock trades — they're mechanical, repeatable strategies that, with the exception of DAA, readers here have been following for years. Sure indexing is easier. But are you really so busy that you're willing to pass on a few extra million dollars of retirement income?

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