Why Saving Is More Important Than Perfect Investment Choices

About once a week, I’ll get an email from a reader along the lines of this recent one from Leo:

I don’t know how to invest. I don’t know what to invest in. So I keep putting it off because I’m worried about messing it up. It’s ridiculous that this is all so complicated.

The path to financial success really isn’t that complicated, Leo, especially when you’re starting out. Your investing choice doesn’t matter much at all at first compared to the importance of simply saving that money. It’s only (much) later on that optimizing your investments really matters.

Doubt it? Let’s say the stock market returns 9% in 2009. You have three options - an investment that will end up only returning 7%, an investment that will end up returning 11%, or fear and procrastination.

If you elect to save just $10 a month and put it in the good 11% investment (compounded monthly), you have $125.40 at the end of the year.

If you elect to save that same $10 a month and choose only the 7% investment (again compounded monthly), you have $123.80 at the end of the year.

Yes, the difference between the great investment and the awful investment is only $1.60. Not much, huh?

Well, let’s compare it to fear and procrastination. That ends up with $0 in your investment account. Compare that to the “worst case” above, where you have $123.80. The “best case” is only $1.60 more than that.

Even if you’re investing substantially more, the difference isn’t that tremendous. If you’re socking away, say, $250 a month, you’ll have $3,095 in the “worst case” and $3,135 in the best case - a $40 difference. With fear and procrastination, you have nothing at all.

Even more impressive, waiting just one month costs you dearly. If you start investing now in the 7% investment as compared to waiting just one month and then starting in the 11% investment, it will take 33 months for the “good” investment to catch up in returns. Wait a year and a half and you’ll likely never catch up.

If you’re just starting out, a relatively poor investment doesn’t matter much at all. What matters is that you’re saving and building up the principal.

If you’re still afraid to take that leap and get your 401(k) or Roth IRA set up because you’re afraid of choosing a bad investment, do it as simply as possible. Choose the broadest investment you can so that you’re essentially in the average of all investments. For example, if you’re opening a Roth IRA at Vanguard, just invest in the Vanguard Total Stock Market Index - you’ll be invested in all stocks and will go up and down with the market as a whole. If you did that in the example above, you’d be right in between the worst and best investments - doing right what the market does - without any worry or research.

Remember, though, starting now, even in a relatively poor investment, is far, far better than being afraid and putting it off. Don’t let fear and procrastination rule the day and keep you from retiring later on.


The Simple Dollar chronicles a man's road to recovery from "total financial meltdown." As author Trent Hamm puts it, "The Simple Dollar is a blog for those of us who need both cents and sense: people fighting debt and bad spending habits while building a financially secure future and still affording a latte or two." We'll post a couple of entries a week, but you can check out his writing daily at www.thesimpledollar.com

 

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