Time and time again I sit down with clients and sense their frustration with the way their Market Based Assets are performing and the rate at which they are building wealth. These Market Based Assets I am referring to could be inside their 401ks at work, old IRA accounts from old employers that have not seen a contribution in years, or Investment Accounts outside of their Retirement plans.
I get countless inquiries questioning if they are in the right investments, taking the right amounts of risk, is the fund manager doing a bad job, or am I working with the right advisor? All fair questions that deserve an answer and proper analysis, however at the end of the day, all they’re really concerned about is the rate of return. But what if I told you rate of return is not that important? I know that might sound crazy but hear me out, because by the end of this blog, we are all going to be saying it together: RATE OF RETURN will NOT save You!!
Let’s first look at exactly what is the rate of return. Personally, I think we flock to rate of return because it’s like an SAT/ACT test score, it’s definable, measurable, and you can compare it with your buddies in conversation. In financial terms this comparison or barometer could be the S&P 500, or simply a friend and his/her successful investing story at the cocktail party. Humans love measurable definable benchmarks. It makes us feel good when we over perform and horrible when we underperform. The irony is that rate of return is not the biggest variable in driving financial success or failure, (just like your SAT/ACT test score doesn’t determine how smart you are or your overall educational success). The time spent on figuring out how we can get 1% or 2% more from our accounts can take our focus off the real impact on building wealth and achieving financial independence: Proper management of cash flow and rate of savings.
When a paycheck or other sources of income come into a household, they are classified in one of two ways: out the door in the form of cost or on your balance sheet to build wealth. The more dollars that stick on your balance sheet, the better your chances are of financial success. As people go through their accumulation phase, adding more and more money to their balance sheet, the wealth building opportunities they can choose to participate in increases. The kicker is, if you do not get a handle on savings and cash flow, you will never be able to participate in these opportunities because the capital will never find its way on your balance sheet. And what is even worse, the average family will lose millions over a lifetime in the form of opportunity cost because they bought too much stuff that does not build any wealth because they saved 5% or 10% and not 20%.
Notice, I used the word opportunities above because I did not want to limit the dollars a person saves to market based assets like their investment and retirement accounts. Why is this? Well, it’s because the wealthiest people I know did not become wealthy and achieve financial independence because they had an awesome retirement or investment account. Instead, most built capital by saving money into some liquid bucket and took a chance on a business, piece of real estate, or widgets. These smart investment moves, along with hard work, are how they achieved their wealth and notice it had absolutely nothing to do with the S&P 500 or their 401k Plan at work. Although the market based assets were probably a part of their savings plan at some point, it was not the driver of their success. The driver of their success was their cash flow management and savings rate, which put them in a position to break free of the rate of return focus and accumulate wealth overtime through proper behavior.
So in closing, if you focus on nothing else, focus on your behavior and how much you are saving in ALL areas. Don’t waste too much time mulling over that 1-2% you could have made but instead, make sure you are throwing as much money on your balance sheet as possible and maintaining plenty of liquidity and saving 1-2% more of your income. Savings rate will ALWAYS outperform rate of return. And who knows, maybe one day you will decide to take that chance, or your rich uncle and/or long lost friend comes to you with that GREAT idea. And if you follow the saving tips I outlined for you above, guess what….you will have the chance to jump on board and capitalize on your decision.
So, as I promised you in the beginning, say it now with me: RATE OF RETURN will NOT save You! Your Savings Rate Will.
Happy Saving,
Ed