Why I am focusing on income and saving before investing
We’re all way too obsessed with investment gains
As the stock market has been wildly gyrating over the past several months, I’ve come to a realization. Everyone is way too obsessed, and spends way too much time worrying about investment gains and losses. Yes, investing is important and it’s the cornerstone of my long term financial plan, but there are so many things that are so much more important to long term financial viability than the day to day ups and downs of the stock market.
The simple truth is that the vast majority of investors are investing very little to begin with, so they are much better served by paying attention to and trying to grow their income and savings rates, rather than thinking about the day to day ups and downs of their stock portfolio, or how to optimize their investments for another 1% gain.
Personally, until I have at least $1m in investments, I am not going to obsess or worry about my investing strategy, but focus all of my efforts on increasing my income and savings rates. I have some data to back this up, which I’ll get to in a second once I explain my philosophy on this a little more.
And just to be clear, I still think it is important to develop a sane, thoughtful, portfolio based on a broad set of low-fee index funds. What I am arguing is that once that has been set up, investors are better served by focusing on income and savings growth than portfolio tweaks or timing.
A time to learn, a time to save, and a time to grow
To flesh this idea out a little farther, let me share the way I have been thinking about my own investing and saving strategy, and how it will change over time. In my experience, there are going to be three distinct periods in my investment lifetime. These periods are defined by the activities that are MOST IMPORTANT at that life stage, and why.
A time to learn (20-30)
In my twenties, I focused wholeheartedly on learning and developing my career by becoming proficient in as many tasks as possible. I started my career making $29,000 a year. It would have been so incredibly pointless for my to pour hours into investment strategy or savings rates at this point in my life, because I wasn’t making any money!
What is the point in saving an extra $50-100 a month, or an added 1% gain on my $5,000 (total) 401(k) balance. These gains are trivial and unimportant.
Instead, I set my index fund investing strategy and forgot about my portfolio. Then, I rabidly obsessed over becoming more useful in my job function and getting as many promotions as possible. This obviously led to increased income, and in less than 5 years I had more than tripled my income and secured thousands of additional stock options. This set me up for the next chapter, the one I am in now.
A time to save (30-40)
Now that I am 32 (ugh, almost 33…), I’ve moved into a different phase of life financially. Although I continue to invest in my day job, and will aggressively pursue success there, my focus has turned to a significantly more important task: saving.
I’ve reached the point where I have enough income that I can save tens of thousands of dollars per year, which will have a significant and material affect on my long term prospects if I am able to focus on doing that.
Although more income increases are good, as I move up the ladder they will become less frequent, smaller on a percentage basis, and less likely to have a material affect on my savings rate. To put that more succinctly, I am not going to triple my income again in the next 10 years. Actually, the best case scenario for me is to eventually take a pay DECREASE to move into a C-level job at a startup where I will have significant and meaningful equity (e.g. 1-3% of the company, which is more than 10x what I have in my current role).
So how am I “focusing on savings”?
First of all, I am refusing lifestyle inflation. With every change I make, I ask how I can reduce my costs. For instance, I am moving to a new city and will be looking to reduce my rent, get rid of my car and car payment, and reduce my gym expenditure. The added cash flow (over $2k per month, or $24,000 a year) is going straight to my investments.
Second, I am thinking about how to increase my passive income. I am raising rents (however slightly) at my rental condo. I am developing this blog and the slow but steady passive income it generates, as well.
Over the course of the next 12 months, including an additional raise at work, I should be able to raise my savings rate to close to 40% of my take home income. That isn’t as crazy as some leanfire bloggers out there, but it’s definitely good for me!
A time to grow (40-50)
In the 10 years before my planned fatFIRE (early retirement), I will THEN, FINALLY, be focusing on my investments. Hopefully by then I will have well over $1m in investments, and be able to hire a fee only wealth manager who can help me to develop the tax advantaged strategies and portfolio that will suit me best for the long run.
The math: why focusing on income and savings growth is so much more important than investment gains
To illustrate why I believe in this strategy so much, I am going to use the Personal Capital retirement planner to show what an enormous difference even small additions to savings can make.
In the scenario below I am only changing a single factor: the percentage increase in savings rate each year. For simplicity sake, I am assuming a 32 year old like myself with $50,000 saved so far, adding an additional $10,000 per year. This is what their portfolio will look like with a retirement at 65 and a 2% increase in savings each year.
As you can see, the Personal Capital retirement calculator is pretty easy to use.
By the time this person reaches retirement, in the best case scenario they will have saved around $600k. Worst case, their retirement savings will be gone by 75-80.
What if we changed JUST the savings rate, and bumped up the annual increase to 4% instead of 2%?
EVERYTHING changes. Over time, the best case scenario increases to almost $1m. The worst case is closer to $600k, and there is a very good chance that their retirement savings will be more than enough to match their income.
Quite simply, focusing on income and savings is the easiest way to increase my nest egg and improve the chances that I will meet my retirement goals. There will be time to focus on investment gains, but for now, I am laser focused on INCOME and SAVING!