As risk-averse as investors have become since the recession, a lot of people remain fixated on returns. They look at their approaching retirement and judge their holdings on the percentages they produce over one-, five- and 10-year periods. That's not the way pension fund managers look at it, though. They focus on preserving as well as increasing the wealth in their care. And research by a major investment firm shows why chasing returns may not be the straightest path to financial freedom after all.
In 2011, The Vanguard Group published a report that concluded saving early and setting aside more money every year had a much greater impact on retirement savings than returns. Maria Bruno, a senior investment analyst, looked at a 25-year-old who earned $30,000 a year. If he invested 9% of his income in a portfolio of 50% stocks and 50% bonds and his income increased 1.1% every year, he would have $539,000 at age 65. If the same person instead invested a little less each year (6% of his income) in a portfolio weighted 80% to higher-returning equities and 20% to bonds, he would only have $469,000 at retirement.
In another study, Bruno determined that someone who saved $5,000 every year with no increases would, at a 4% return, need about 70 years to reach $500,000. An investor who increased his savings rate by 5% a year, by contrast, would need about 35 years to reach that mark. Someone who increased contributions by 10% a year would reach that figure in just 20 years.
Chasing returns doesn't work, she says, because investments are volatile, and there's no such thing as a guaranteed return. As well, compounding plays a much bigger role in savings growth than how much you can make in the market in any given year. "It's earnings on earnings, and that has a snowball effect," she says.
The point, says Bruno, is that investors should focus less on returns and more on boosting their savings every year . If your income is increasing even gradually, then that shouldn't be hard. Automatically up your RRSP contribution by even 1% annually, she says. "Do it automatically and you can increase it without having to make a conscious decision to save more."
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