#696 - Savings vs. Returns: What's More Important?

The "Daily Call" From Option Alpha

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we’re going to be talking about savings versus return and asking the question, “What’s more important?” And I think this is important to actually ask yourself. Right now, just really quickly, before you do anything else, what is more important over the course of 20 or even 40 years? Is savings more important or are investment returns more important? And I think the results here actually are not that surprising, though I think they might shock some people in the sense that when you look over a 40-year period and you compare let’s say a 10% savings rate and 6% return to a 6% savings rate and 10% return, when you actually go to about your 24, 25, the difference is mostly on the end of savings. And so, what I mean by this is that when you have 10% savings and a 6% return, that far exceeds the performance of saving 6% and earning 10% and that’s all the way out to the first 24, 25 years of your investment horizon.

What can we learn from this? Well, if you’re trading on a much shorter time horizon or if you’re just trading in an environment where you’re looking at performance over the last two years, three years, five years, even 20, 25 years, what matters more so necessarily than your investment returns though, obviously hopefully they’re positive, is the amount of money that you’re contributing and saving in your account. And once you actually get past that 24, 25-year period, then and only then do investment returns matter more. That’s where the payoff of 6% savings and 10% returns start to really compound on top of itself. And so, from say 25 years until 40 years out in the future, that’s where the 10% return type of model portfolio starts to really pull ahead of 10% savings and 6% returns. Again, later in the cycle is where compounding starts to really take form. Hopefully you do both of these. Hopefully you have 10% savings and 10% returns. You’d crush both of these, but the idea here is that in the first few years of what you’re doing, savings matter more so than anything else and it’s because it allows you to get that steady base of cash flow coming in and then you can start focusing more on higher returns in the future once you have a nice cushion in place to kind of withstand the blow if you will. Hopefully this helps out. As always, if you have any questions, let us know and until next time, happy trading.