Contributions or Returns? Which is Better?

open egg“Any investment portfolio has two engines of growth: the contributions made by the investor, and the rate of return generated by the portfolio. But which has the greater impact?” says Dr Craig Israelsen in Financial Planning article titled “Best Way to Bulk Up.”

His findings echo those of mine that I posted in a blog here.

Dr Israelsen finds that for those younger than age 45, increasing returns has a greater impact than increasing savings. He cautions though that this does not mean that the young can reach their goals by under saving. No, they should save as much as they can as early as they can, and avoid the attitude that todays wants can overpower their needs for later.

For those older than 45, increasing contributions provides a greater impact.

What favors the young is that they have time: time allows them to 1) reach for more risk because the have more time to overcome the downside that more risk has; and 2) the effect of compounding doesn’t kick in until the later years – years only the young would have. The cost of delay essentially means that compounding is limited (in other words, older contributors by starting late don’t have those later years of compounding because the retiree has started taking money out before compounding can really start – they’ve lost those end years).

Even though is sounds simple for those under 45 … to take on more risk by reaching for more return … remember that returns are NOT under anyone’s control. At any age, contributions are always under everyone’s control.

Moral of the story: At any age, save as much as you can towards retirement. Your future-self will thank your present-self for doing that. How do I know? How many times have you heard someone say “I wish I had started sooner.” or “I should have … ”

 

About Larry Frank, Sr.

Larry R Frank Sr., MBA, CFP®, is an experienced financial advisor and a published author on Retirement Planning Research. Have a financial question? Click Here to Ask Larry

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2 Responses to Contributions or Returns? Which is Better?

  1. Larry Frank, Sr. July 26, 2013 at 4:42 pm #

    A good question I’ve received by email … does compounding still work? Yes, compounding still works. But … it won’t work strong enough to reach a target number as compared to saving more. Savings trumps returns over shorter periods of time before retirement.

    Compounding still works once retired too. However, the real question here once again related to saving … except now it is the flip side of saving called spending. The challenge once retired is measuring prudent spending based on expected longevity time frames at each age you reach. I describe that in this blog http://blog.betterfinancialeducation.com/sustainable-retirement/just-what-should-an-annual-checkup-do-for-you-during-retirement-part-2/

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