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[Note: Today's post is an excerpt from a recent new book titled "You Can't Eat Your Furniture: A Simple Plan For a Well-Fed Retirement". The author, Robert Chown, is an investment advisor with one of Canada's leading investment firms. In the first chapter, part of which is excerpted below, Mr. Chown argues that only two factors matter when it comes to retirement planning: the rate of savings and the rate of returns. It may just be common sense but the basics are often forgotten in personal finance discussions. Enjoy...]
My clients are mostly well-educated, intelligent, high-earning professionals who have everything going for them from a financial standpoint. But before they sought my advice, many were not on track to reaching their financial goals. As often as not, they didn’t even have clearly defined financial goals.
If these folks find it hard to set and achieve such goals, then obviously income, intelligence, and education are not prerequisites to achieving financial security. This is good news for the rest of us!
No matter who you are, achieving your financial goals can be simple. Consider, for example, the goal of building a retirement nest egg. From a purely mathematical point of view, success or failure rests on only two variables: your rate of savings and your rate of return.
Your rate of savings is how much you save for retirement, and when you save it. Your rate of return is a measure of the performance (over a given period of time) of the investment products in your portfolio. Investment products can include stocks, bonds, mutual funds, real estate, and guaranteed term deposits, to name just a few.
These two variables are equally important. For instance, your rate of return may be stellar, but you will not accumulate enough capital if your rate of savings is too low. Conversely, your rate of savings may be adequate, but you will not accumulate enough capital if your rate of return is too low. Either way, if you don’t accumulate enough capital, you won’t be able to retire as soon as you planned to, or you will have to get by with less retirement income than you had hoped for – or both.
Now that you know that only two variables determine your success, you can create a simple mathematical model of your retirement strategy. Once you assign a value to one variable, you can calculate the other. For instance, if you assume a rate of return, you can calculate how much you need to save over a given period of time to achieve your retirement objectives. If you assume a rate of savings, you can calculate the rate of return you need to achieve your retirement objectives. Many financial management software products and websites have tools to help you perform these calculations.
From a mathematical standpoint, everyone who starts with a reasonable set of assumptions should be able to find out what they need to do in order to meet their retirement goals.
If It’s So Simple, Why Doesn’t Everyone Succeed?
We’ve now narrowed down the entire financial planning and investment industry to only two variables, the rate of return and the rate of savings. Everything else is superfluous. This means that you need to focus on just two things for your retirement strategy to succeed. But it also means that there are only two things that can cause your retirement strategy to fail: either you don’t save enough or you don’t get an adequate rate of return. This may seem simple, but if you don’t have a plan, you can be sure that distractions, temptations, and human foibles will conspire against you.
[You can read the rest of Chapter 1 here. The book is available on Amazon.ca for around $15. I'll be posting my book review in the near future.]
Bookmark:
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6 responses so far ↓
1 The Rat // Nov 8, 2009 at 7:27 pm
Seems like an interesting read; I like the approach of simplifying it down to the two approaches (rate of return and saving). Nice thread
The Rat
2 Ben // Nov 9, 2009 at 9:22 am
I liked the first chapter.
Seems that more people focus on rate of return than on rate of savings. It is more exciting to hit a “2-bagger” on a penny stock than to save more money. One gives you bragging rights, the other nobody wants to hear about.
I still spend more time thinking about rate of saving than rate of return. We see a better return from saving an additional 5% of our income than from earning an additional 5% on investment.
This won’t always be the case, of course. In the next few years the focus will shift to rate of return, while keeping on auto-pilot the learned lessons of saving and cashflow management.
3 Canadian Capitalist // Nov 9, 2009 at 11:16 am
@Ben: I agree. It is more sexy to talk about rate of return than the rate of savings, though arguably, it is the rate of savings that matters more. It is also the rate of savings that is completely under our control. The rate of returns depends on what the market gods decide to give investors though capturing almost all of that return is in our hands.
4 Basil2 // Nov 9, 2009 at 4:04 pm
Author is making it sound simple. It’s not.
Only one variable is (sort of) under your control: saving rate. That return is not predicatable makes it difficult.
5 Canadian Capitalist // Nov 9, 2009 at 5:44 pm
@Basil2: True but many factors that trip up average investors are under our control. We can control emotions by investing according to a plan. We can control expenses by paying attention to investing costs. I think it is simple, but it definitely is not easy.
6 boko // Nov 9, 2009 at 10:09 pm
rate of savings ok, rate of return is jibersih..theoretically it sounds fantastic, now get passed the criminal elite to make your rate of return..very hard to do unless you make investing a job.
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