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From concerns over global markets, politics and bubbles to worries about inflation, taxes and fees, investors have many things on their minds today. So much of what happens in the markets is out of any investor’s control. But investors have nearly complete control over the two most significant factors determining their lifetime investing outcomes:
- Spending less than they earn.
- Committing to more equity exposure.
The degree to which individuals save (as a percentage of their income) and the degree to which they commit to owning stocks (as a percentage of their portfolio) are directly related to financial success. If investors get these two things right, almost nothing else will matter. If they get them wrong, focusing on those other concerns won’t help at all.
Of course, what is appropriate for each person is based on his or her goals, capacity for saving and risk tolerance. It’s also important to understand the trade-offs: Saving more means deferring gratification, while maintaining exposure to stocks means welcoming volatility.
In the context of a personal financial plan, people have many goals, including educating their children, saving for major purchases, caring for aging parents, enjoying a certain lifestyle in retirement or leaving money to family or charity. The higher their savings rate and the greater their exposure to equities, the more likely they are to achieve these goals.
Some people, of course, cannot save 10% or more of their income, as is commonly recommended. Others cannot commit to owning equities because they know they simply cannot endure market volatility without altering course. Although it’s possible to adjust the balance between the two — saving more if you can’t stand volatility, or putting more into stocks if you can’t save as much — those who are able to do both will almost inevitably see the best results.
Doing both, however, involves accepting those trade-offs.
Deferring gratification means missing out on something today, but there’s a very strong psychological pull to spend now. “Live for today, since tomorrow may never come,” the saying goes. The opportunity for future gratification simply doesn’t have as much power over us as the desire to get what we want right now. But remember: It is still a choice, and because of compound returns, you will be increasing that future gratification and your total lifetime gratification by holding back today.
Having a higher percentage of your invested assets in equities, meanwhile, can produce stomach-churning volatility. But don’t confuse this volatility with risk. It only becomes increased “risk” when you act on it by buying high and selling low. Historically, patience wins the day, and that means riding out the ebbs and flows inherent in the market.
That said, it’s critical to understand how much volatility you can stand without it becoming a weight around your neck. If you cannot stomach much, you will have to save more and spend even less today. If you can seriously commit to more stocks, you may be able to spend more today.
Beyond these two crucial factors, everything else — including timing, investment product selections, choosing active vs. passive investments, employing complex investing strategies or whether you work with an advisor — amounts to rounding error. So save more, hold a broadly diversified basket of as many equities as you can stomach and be patient. Be disciplined and believe in your plan. Then go read a book. Or, write one if it suits you.
This article also appears on Nasdaq.
Image via iStock.