In my previous post, I had talked about three factors that contribute to the wealth that we build, namely
- The amount that we save and invest
- The timeliness of our investments (i.e. regular investing, without delay)
- The quality of our investment choices
I also mentioned that in my experience, far too many of us focus our attention on the quality of investment choices, losing sight of the first two factors. In this post, I would like to make the case that while it is important to make good investment choices, it is far, far more important to save and invest as much as we can, and to invest regularly, without delaying our investments.
Time is money
The time that we stay invested has a strong influence on the wealth we build. Procrastination, or even a tendency to wait for a better time to invest, can rob us of the opportunity to fully use time to our advantage. The impact that this has on our potential wealth is such that to compensate for any delay, we need to earn a rate of return that is disproportionately higher, and which may not be achievable. Let me demonstrate this with an example.
Let’s say that a person has a financial goal that needs to be accomplished 10 years from today. Towards this, he invests an amount of 100,000 each year, starting today, for 5 years. After that, he makes no further investment, and holds his accumulated investment. Let’s say that this grows to a value of 900,000 at the end of 10 years from today. This means that his investments have delivered a compounded return of 7.55% p.a.
Let’s now look at a scenario where he delays his investments by 5 years. For his investments to now grow to a value of 900,000, he has to earn a significantly higher return of 20.28% p.a.
No matter what numbers we take, or how good be our investment choices, any delay in investing will require an unequally higher increase in the rate of return to compensate for that delay. This may even need us to take far more risk than is desirable, or we may be comfortable with. This makes the case for regular investing, which is widely regarded as the best antidote to procrastination. There is far more truth to the saying, “The best time to invest is when you have money,” than a number of us realize.
Our savings are the most controllable factor
The amount that we save has a direct bearing on the wealth that we will build. Any increase in our savings will proportionately increase the wealth that we will build, all else remaining the same. Saving more can also help reduce the rate of return needed to meet our financial goals. Its greatest significance, relative to the other factors, is the degree of control that we have over it. Let me explain.
There is a practical limit to the rate of return that we can earn from our investments on a sustained basis. For instance, in a country such as India, it would be very difficult to earn more than 15% p.a., year after year, or over a lifetime (some may even question our ability to earn anything close to that).
In contrast, the amount that we can save, has fewer constraints, largely because it is linked to the earnings from our profession. There are no limits to the potential of professional earnings. It is up to us to seek out a line of work offering greater opportunities to enhance our income with lesser threats. It is up to us to be in an occupation where there is a good match between our strengths and the requirements of the field. It is also up to us to decide the share of savings to our income.
In case you find that hard to buy, you may like to check out the book, “The Millionaire Next Door.” In it, the authors mention seven common characteristics that they identified among those who had successfully built wealth. One of these was that they all lived well below their means. Another was that they chose the right occupation.
Let me now put all of this together and summarize my case.
Our ability to save more and invest regularly will have a significant influence on the wealth that we build. Saving more and investing regularly can bring down the rate of return we need to earn on our investments while not doing so can need us to take far more risk than is desirable, or we may be comfortable with. Thus, while it is important to make good investment choices, it is far, far more important to save and invest as much as we can, and to invest regularly, without delaying our investments.
