Guest blog post from Certified Financial Planner Alexander Collins, ChFC®, CFP®. Alex and his partner Ryan Burklo are with Quantified Financial Partners. Learn more here: www.quantifiedfinancial.com
Alex and his team work to enhance their clients’ lives delivering unending cash flow, and a consistent client focused process through coaching and education.
Our industry has spent years chasing rate of return. Trumpeting results and what percentage of their funds “Beat their Lipper Average”. Encouraging folks to chase after the ever elusive best performing stocks, mutual funds, REITs, ETFs or insert financial product here. I’m here to tell you while it may be sexy, interesting, challenging or exciting, it is absolutely the wrong thing for an individual to focus their attention. Your rate of savings will have a much stronger correlation with the amount of wealth that you build than your rate of return. Better yet, it is easier to accomplish and predict rate of savings than it is rate of return.
Why has the industry focused on the pursuit of Rate of Return? Well for starters saying “we are just as good as the other guys” won’t bring in dollars to your firm, fund, strategy, etc. Secondly and more importantly, the only thing Wall Street really cares about is having us trade as continuously as possible. It has little to do with the ‘cost’ that you are shown – $7 per trade. Wall Street in some aspects is not unlike a Casino. It allows people to speculate. Some investors do much more so than others. Just like a Casino, Wall Street has a way of taking a rake.
What is rake? It’s a poker term for the ‘commission’, typically 2-10% taken from every poker hand played by the host/casino. What is the rake in the investment world? It is the Bid-Ask Spread. This is the difference between the cost to purchase and the proceeds from the sale of a security. It goes to the financial firm that acts as the market maker. The company that physically puts the buyer and the seller together. The good news for investors is that Wall Street is not a closed system where the results are zero or even negative sum. What this means is that it is possible for an investor to win without another investor losing.
The math behind proving savings rate trumping rate of return isn’t terribly challenging. Our investor has an annual income of $100k per year. Let’s compare a world class investor who gets a 10% net after tax rate of return for 30 straight years and saves 5% of their income. At the end of the 30-year time period, this client would end up with $904,000. If instead we have a world class saver who saves 20% of their income but only gets a 5% percent rate of return, this client would end up with $1,395,000.
As you can see from the numbers, we were able to create an additional $400,000+ by being a world class saver compared to a world class investor. Lastly, there is no additional risk by saving more money when compared to attempting to beat the market.
Photo credit: Ken Teegardin on Flickr