Stop Focusing on Investment Returns: Here's What You Should Focus On First Instead
Most of us would know that the stock market took a huge dip in March last year.
Those who managed to dip their toes into the stock market back then would most likely be sitting on pretty decent gains today.
With this phenomenon, we have seen a rise in the number of people making claims on their impressive investment returns these days.
Which has led to an increase in the emphasis on having investment gains that ‘beat the market’.
Now, I’m not saying that the percentage gain in investments is not important.
If you’re proficient in investing, the chances of you growing your wealth exponentially would be much higher.
However, a lot of us are not gurus in investing.
The bulk of us does not spend enough time deep-diving into individual companies to identify multi-baggers.
However, a lot of beginner investors tend to place a lot of emphasis on investment performance.
When we should first be focusing on the accumulation of wealth through earned income, especially at the start of our financial journey.
TL;DR: Here’s Why You Should Focus On Your Savings First Instead of Your Investment Returns
- When your portfolio size is small, the investment returns are not significant enough
- Savings make up most of the portfolio for the first $100,000
- We should prioritise on accumulating enough capital to make investment returns meaningful
- The focus on investment gains can take precedence with a decent portfolio size
Why Your Savings Matter More (Especially at the Beginning)
I was recently chatting with an acquaintance who got into the stock market not too long ago.
Knowing my interest in investing, he tried to recommend me the investment course he was in.
He started by showing me his current portfolio which showed 20% gains within a short span of time.
Ultimately, he revealed that his portfolio size was $4,000.
While the percentage gains seemed great, the absolute return in a year would only amount to $800, which is definitely not significant enough to move the needle on one’s net worth.
To put things into perspective, here’s an interesting table that shows how much of your net worth would come from investment returns.
To simplify matters, this is based on the assumption that:
- $10,000 is invested every year
- Investment returns are 7% annually
|Net Worth||Amount from Savings||Amount from Investment Returns|
|Assumption: Invests $10,000 a year with a 7% annual rate of return|
From the table, we can see that for the first $100,000, 78% of your net worth would come from savings, and 22% will come from investment returns.
As our net worth moves from $100,000 to $200,000, the power of investment returns can be seen as almost half (49%) of your net worth will now be from investing.
We can see that on our quest to our first $1,000,000, investment returns would eventually take a larger slice of the net worth pie.
This is mainly having a broader base for the popular compounding effect to propel your net worth further.
This also means that if you have less than $100,000, your investment returns wouldn’t be significant enough to increase your net worth.
The Importance of Saving Your First $100,000
This brings us to the importance of saving our first $100,000.
You’ve probably heard of the ‘Save Your First $100,000 By 30‘ goal.
But why this financial goalpost?
Because the path towards the first $100,000 is the toughest climb of all.
To quote one of the greatest investing minds of the 20th century, Charlie Munger reportedly mentioned this during a Berkshire Hathaway shareholder meeting in the 1990s:
The first $100,000 is a bitch, but you gotta do it. I don’t care what you have to do – if it means walking everywhere and not eating anything that wasn’t purchased with a coupon, find a way to get your hands on $100,000. After that, you can ease off the gas a little bit.
The wealth accumulation to the first $100,000 is often the slowest and most painful because most of it would come from our savings.
Which tend to require more discipline and some occasional sacrifices.
Now, you don’t necessarily have to save $100,000 by 30, but having this amount would mean a much easier climb to the next $100,000.
Earning Power: Your Biggest Asset While You’re Young
Your earning power is the biggest asset, especially in your early days.
Most people’s primary source of income would be from their day jobs, otherwise known as earned or active income.
This means exchanging the bulk of our time for this form of money.
To showcase the importance of income, here’s a scenario:
Bob is currently a salaried worker who earns $3,000 a month.
He invests $10,000 into stocks, and hopes to double his rate of returns from 10% to 20%.
If he manages to do that, he will be able to get an additional $1,000 a year.
However, if he attains skills that increase his employability and allows him to earn $5,000 a month instead, he will get an additional $24,000 a year.
Building a decent portfolio size is essential for significant investment gains, and our earned income forms the building blocks of our capital.
As such, it is very important to invest in your career and stretch your earning potential.
Ways To Stretch Your Income
Now that we’ve seen the importance of stretching your income, here are a few methods to do so.
1) Ask for a Pay Raise
You don’t always need to job hop to get an increase in income.
If you’re someone who loves your company and do not forsee yourself switching jobs anytime soon…
One way you can do so is to ask for a pay raise.
This method is useful if you’re a valuable employee with sufficient reasons to justify for that salary bump.
2) Look For Better Job Opportunities
Did you know that employees who stay in companies longer than 2 years get paid 50% less?
While this study is based in the U.S., we can expect similar trends in Singapore as well.
Significant salary bumps are usually seen when one switches jobs, with an average raise being between a 10% to 20% increase in salary.
If you’re someone with skills that are highly sought after, you would be in a great position to leverage these skills for increased pay.
This means that it is very important to upskill, especially in areas that are in high demand in the current workforce.
3) Keep Expenses to the Minimum
As our income increases, it is very easy to give in to the lifestyle creep.
It usually happens unintentionally, mostly us being more willing to spend due to an increase in disposable income.
Keeping our expenses low requires a lot of discipline, but is definitely possible.
One way to do so is to make it into a lifestyle that is still tolerable (not too extreme till it feels like suffering), and stick to it.
Personally, I love seeing saving money as a challenge, and achieving saving goals is absolutely gratifying to me.
Gamifying my expenses was a way that helped me keep my expenses low which eventually leads to an increase in my savings rate.
Should We Never Focus On Investment Returns Then?
Of course not.
As we can see from the table earlier, investment returns are very significant once the portfolio size gets bigger.
If you’re someone who wishes to maximise returns from stocks investing, you might be on the hunt for value or growth stocks.
With a bigger portfolio, that’s when you can shift your focus and dive deeper into asset allocation and beating the market.