Now is the time to start making adjustments in your portfolio – and even in your daily life – that can help keep you moving towards your goals.
Let’s quickly review the three fundamental levers that impact your personal wealth:
1. The return you earn on your investments
2. The amount of money you save
3. The amount of time you allow your money to grow
Let’s look at each of these in more detail.
1) INVESTMENT RETURN
The composition of your investment portfolio – asset allocation, quality of holdings, level of diversification and annual fees and other costs – largely determines what you earn on your investments. Once you have the proper asset allocation and a diversified portfolio in place you have very little direct control over your actual return, because it’s highly dependent on market behavior.
However, you very likely have some control over what you pay for commissions and account fees. So it’s worth focusing on getting the best value and minimizing your costs. Remember, it’s not what you make that is the most important, but rather what you “take” that is most important.
That said, many investors focus too much on returns—the asset side of your balance sheet. Let’s move to the liability side of your balance sheet where you can wield some real power over your ending wealth by adjusting your cash flows.
2) AMOUNT OF MONEY YOU SAVE
Relatively simple changes to your daily routine can increase the amount of money you’re able to save each year. And the sooner you make these changes, the more time those savings have to grow.
Start by cutting out some unnecessary luxuries or bad habits from your daily routine—and improve your health while you’re at it. For example, buying a grande caffe mocha five times a week instead of a large, black coffee can cost around $500 extra each year. If you’re a cigarette smoker, cutting out two packs a week could also save you over $500 a year.
Those weekly savings could add up over time. Giving up a $1 Lotto Scratcher each week is $52 a year—over 20 years, grown at 8%, that could be over $2,500. And forgoing a large $5 popcorn each week at the movies could yield nearly $13,000 over a 20-year period. Suppose you invested that $10 a week you saved by buying black coffee instead of a mocha. After 20 years at a modest 8% return each year, you’d have over $25,000.
These are just some simple ways to save. There are other, even more effective ways like consolidating debt or refinancing your mortgage. And consider what you could do with the money you save. You could invest in a tax-advantaged, employer-sponsored retirement plan like a 401(k), or fund an IRA.
3) THE POWER OF TIME
The third lever that impacts your eventual wealth is the amount of time you allow your money to compound. Albert Einstein famously referred to compound interest as the greatest mathematical discovery of all time. Take this example of two investors: Investor A invested $2,000 a year for 10 years and then let it compound for another 30 years. Investor B waited 10 years before investing, then invested $2,000 a year for the next 30 years.
If each earned 8% a year, Investor A would end the 40-year period with $315,000, vs. $245,000 for Investor B. Even though Investor A contributed only $20,000 compared to Investor B’s $60,000, Investor A still came out ahead because of the earlier start and longer time to compound. The sooner you make those investments, the more time is on your side.