The Best Way to Maximize Your Investment Return
There are three variables that impact the total return investors receive from an investment: the amount saved, the return rate, and the amount of time invested. Most investors spend a good amount of time and effort trying to increase all three. But what if we can't do all three, if we're inhibited by time, skill, knowledge, or ability (after all, many fund managers spend a lifetime trying to eek out an additional 1% return with limited success.) If we could only focus on one of the factors to impact, which is the best option? What is the best way to maximize investment returns?
When you increase the amount saved by 20% per year, your overall increase is 20%. This seems to make sense and be "fair." But if you increase your return rate by only 12.5%, you get a 20.3% increase in the total, a much better result. Yet when you save for an additional five years, a 16.7% increase in time, you get a much, much better return — an increase of 46.9% total.
In other words, the amount of time you save has the biggest impact on your total return by far.
So what does this mean? For younger people, it means they should save as much as they can as early as they can. Someone in their 20's still has a great many years ahead of them. The best thing they can do to influence the amount of money they earn throughout their lifetimes is to save and invest as much of it as they can right now. Starting immediately and keeping at it for 30 or 35 years will give their investments a tremendous boost.
For those of us who are older, it means we need to start saving now. Even though we have less time, the more time we have our money working, the better total return we can expect. The old saying certainly holds true in this case: "The best time to plant a tree is twenty five years ago. The next best time is today."
And for you over-achievers, if you increase all three factors (something we all really should be trying to do), you get a marvelous result:
If you do all three — increase the rate, increase savings, AND increase time — you really get a huge impact. The amount at the end of the 35 years grows to 129% more than the initial scenario.
The Best Way to Maximize Your Investment Return [Free Money Finance]
— FREE MONEY FINANCE (Photo: unleashedlive)
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Comments:
I'm 27 and this will be the first year I contribute the max amount allowed ($16.5k) by the IRS into my 401k. Having no kids helps so I'm trying to pump as much in while I'm free of critters.
@HIV 2 Elway: Great job!! You will not regret that. Also - if you qualify - contribute another $5k to a ROTH IRA. One benefit of having the 401(k) and the Roth when you retire is that you can pull money from both the 401(k) (which will be taxable income when you pull it out) and the ROTH IRA (which will not be taxable income when you pull it out). That way you can pull from the 401(k) to the point that you max out the lower tax brackets and then take the rest from the ROTH, so you don't have to pay income tax at the higher tax brackets.
@Saboth:
Or he could just have very low living expenses. A lot of people his age spend $500 a month on a nice car. Drive a beater and you save $6k. Add a 50% employer match and you're halfway there.
@HIV 2 Elway: I would agree with pupu that it makes sense to diversify, if you're not doing that already (which is what I'm assuming, based on your 401k contribution levels). A Roth IRA (particularly if you're young since gains will not be taxed, and investing at a low point in the market makes this kind of account even more desirable), or even a traditional IRA is an effective investment tool to use in addition to the 401k. Most employer 401ks I'm familiar with have a very limited investment selection, while an independent IRA gives you much more freedom.
Index funds with low expense ratios.
My employer used to match the first 5%, which was pretty decent. When the economy went bad, they used that as an excuse to drop it to 3%, while cutting other benefits. Nevermind the fact we are as busy as ever, and they will make record profit this year.
But yeah, I guess if I didn't have student loans and a house payment, I might be able to come close to that 16k too.
@bilge: ...would still have lost you 40% in the last two years. The two biggest ways to maximize your return are 1) ALWAYS add to your investable money and 2) remember it's OK to take small losses to avoid taking bigger ones. It requires a lot of attention and a bit of work but this is YOUR money --dontcha think you should be paying attention to it?
@HIV 2 Elway: Wow, that is like a mythical creature- heard about but never seen first hand...Congratulations!!!
If you are not married definitely get a prenup to say that all retirement funds are only yours though until both of you retire at age 70 (or whatever the age will be then) or you die and leave it to her in transfer documents. If you are married now, I would get a document written up to say that for both you and your spouse's retirement funds. I know it stinks but it is better to CYA.
My credit card worshipping ex-wife snagged half of my retirement funds because she never saved(s) for the future. Heck, I had to practically drag her into setting up an IRA with $250 years before. And when our marriage was going down the tubes, guess what the first thing she cashed out was- that now $290 IRA...
When she cashed out the retirement funds I had to give her, she tried to stick me with the taxes via her scumbag "financial advisor" father. No better "STFU" moment when I got to stop the IRA transfer with the words "Fraud and Forgery" and have my lawyer say those same words to that idiot...
Just be wary...
Oh boy. I don't know how to put this nicely but the poster has a fundamental misunderstanding of the financial terms he is using. For starters, try googling "total return"
Ha ha, I have finger-people art on my non-dominant hand almost all the time. This article made me feel like less of a freak.