“V for Vendetta” is one of my favorite movies. In one scene, the main character, V, is being shot repeatedly, but the bullets are not having much of an impact on him. The man with the gun screams, “Why won’t you die?” V responds, “Beneath this mask there is more than flesh. Beneath this mask there is an idea, and ideas are bulletproof.”
Ideas are bulletproof. This is a powerful line. “Ideas are the currency of life”, says James Altucher. “…good ideas buy you good experiences, buy you better ideas, buy you better experiences, buy you more time, save your life. Financial wealth is a side effect of the “runner’s high” of your idea muscle.”
Every great product or service or book or movie or TV show or blog post started with an idea. This post was inspired by this idea…
Your savings rate is more important than your investment returns when you are first starting out.
I don’t remember where I first read about this idea. But it has had a profound impact on my thinking because I am someone who is just starting out.
For example, let’s say I have $10,000 in an investment portfolio and it gains or loses 10% this year. This means my portfolio increases or decreases by a thousand dollars. A thousand dollars might seem like a big deal right now, but it will have a minuscule impact on my long term wealth. Saving an additional $10,000 at this stage over the course of a year would increase my wealth significantly more than realistic investment returns would.
Let’s dig into this idea a little deeper. Meet Bob and Rob, both of whom are a figment of my imagination. They both earn the exact same salary. Bob saves $5,000 per year and manages to get a yearly return of 10% on his investments. On the other hand, Rob saves $10,000 per year and gets a 5% yearly return.
At face value, Bob might seem way more successful than Rob. He has experienced investment returns that were two times higher than Rob’s returns. Yet after 15 years, Rob has accumulated over $50,000 more than Bob.
As someone who is just starting out, I have been guilty of micro-managing my investment returns. It’s as if my investment returns are not only tied to my net worth, but also my self worth. Each percent return seems like such a crucial number. Investing is emotional. It’s stressful.
A big takeaway from the idea that your savings rate is more important than your returns in the beginning is that it is ok to make mistakes when you first start investing. Sure at this very moment a 5% return seems way worse than 6%, 7%, 8%, 9%, 10%, 20%, etc. It is so easy to lose sight of the bigger picture by getting caught up in comparative numbers. But building wealth is a marathon, not a sprint. The goal is to learn and build a strong long term process, as opposed to trying to maximize short term outcomes.
I’m not saying investment choices aren’t important. They are. But returns start to become more important once you have a larger amount saved. Let’s continue the above example of Bob and Rob. Despite being over $50,000 behind after 15 years, Bob makes almost $1.2 million dollars more after 40 years than Rob. This shows the power of compound interest, especially on a large sum of money.
Focus on what you can control
Our savings rate is something we can control. We can increase the amount we save by playing both good offence (growing our income) and good defense (cutting expenses). Investment returns, on the other hand, have a lot more uncertainty. History tells us that the stock market will go up in the long-term, but where it goes in the short term is out of our control. Natural disasters. Terrorism. Bankruptcies. Scandals. Recessions. These negative events have happened before. They will happen again.
People often use a projection of around 7-8% after inflation for future stock market returns. However, this is a long term average doesn’t capture the volatility of what is actually going to happen along the way. It makes it seem like your journey is going be like driving with your windows down, listening to music on a warm summer day. And certain times will definitely be like this. But there will also be bad times. Times when you are stuck in bumper to bumper traffic in the pouring rain on a windy day with multiple accidents along the way.
So yes, in the long-term our returns have a huge impact on our wealth, but this impact becomes more relevant once we reach a certain level of savings. The difference between an 8% return and a 10% return on a $5,000 investment in a year is $100. Saving an extra $10 per month will yield a higher amount over the course of a year. Here’s an idea: if you are like me and just starting out, it might be more beneficial to focus on what you can control and increase your savings rate before stressing over your returns.