8 Key Factors that Determine Long-Term Investing Results
- Monday, January 23, 2012
Focus on what you can control rather than worry about what you can't.
That’s an important counter-weight for those worried that we're headed for hyper-inflation from all the recent government spending. Or a massive bear market. Or any of a number of events that could impact your investment returns over the next several years. Being fearful is easy, but unproductive.
Instead, think about this with me for a moment. The amount of wealth that you and I can accumulate through investing is determined by a great many factors. The one we tend to concentrate on, of course, is:
• The rate of return. Trying to earn a higher rate, of course, accounts for all the time we spend attempting to pick winning stocks, the best funds, or the most astute market forecaster.
Unfortunately, the actual return we earnis the one factor that's essentially out of our control (unless we're willing to settle for guaranteed CD-like returns). No matter how hard we study or how much we know, we can't predetermine exactly what our rate of return will be.
So doesn't it make sense to turn our attention to the factors where we do have control? As in:
• Whether we're building on a strong foundation. We don't have as much to fear from economic storms if we're debt-free, have an emergency reserve, and live on a budget that produces a monthly surplus.
Our ability to put such a foundation in place is affected by how big a house we buy, how new a car we drive, how responsibly we handle credit, and a host of other decisions — most under our direct control.
• How much we save. Invest $200 a month for 20 years at 10% 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 we 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 we save. Compound-growth examples show that amazing things happen when we leave money invested for long periods of time. This means we should start contributing to our investment accounts as early as possible and plan to leave the money working tax-deferred for as long as possible.
• How much we invest in stocks versus bonds. During times like these, 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 about a 9% annual return. By changing the mix to 60% stocks, 40% bonds, the average annual return climbed to almost 11%. This includes the brutal 1930's bear markets, 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 we'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 we 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 listed above are under our control. Focusing our energies on maximizing their effect on portfolio growth will contribute far more to our success than hit-and-miss efforts to raise raw performance results.
Published since 1990, Sound Mind Investing is America's best-selling financial newsletter written from a biblical perspective. Visit the Sound Mind Investing website .
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