Can Chasing Returns Really Save You?
What if you could get what you want, and where you want, with less risk of failure along the way?
Read that again.
Isn’t that what everyone strives for? To get where they want to go with the highest likelihood of success?
For the folks who have met me, they know I am not a fan of the “pick a number” retirement strategy like what ING was touting to people years ago. If this was a viable strategy, don't you think more people would be happy with their personal finances?
For this example, we need to pick a number for context in order to understand the concept and factors at play. So here we go.
This is all about saving. Saving money is the gas that goes into your financial car every month. Without saving, you won’t be able to get where you want to go (as fast as you could). Let’s assume for a moment that you are making $100,000 (as an individual or couple – doesn't matter) so that my math is pretty easy to grasp.
You look towards the future and decide that it is important enough that you save 20% of your income, or $20,000 per year. That’s great. Now based on the calculations you have done, you have decided that you need $2,000,000 saved up in 40 years in order to retire. That means you need to generate a 4.05% return over the next 40 years in order to achieve that number.
Now, let’s keep everything the same, but decide you only want to save 10% of your income ($10,000 per year). Obviously, now you are not able to accept a 4% return in order to get to your number. You are forced to chase a higher rate of return over time; or adjust your number down to $1,000,000 (50% less than what you wanted). In order to get to your $2,000,000 number, you need to generate a 6.754% return. That’s 40% more than our original example of 4.05%!
So by under-saving, you are forced to take more risk in order to get where you want to go. And with risk comes a greater likelihood that something happens to derail you, or you experience greater volatility over time.
Most people want to avoid risk. Risk is a scary word. It doesn’t bring a lot of warm and fuzzy feelings. As a society we are more risk-averse than risk-takers. The struggle people have is saving the right amount of money, and because of that, most people are forced to do something they find very uncomfortable – taking more risk.
So what is risk, and how do we define it?
Thanks for reading! If you enjoyed it, send me a note on my website at www.mblakemiller.com or post a comment on Facebook or LinkedIn. Share it with your network, and let’s get the conversation started!