We could talk until we’re blue in the face about the right way to invest, and to be honest with you none of it would matter if you didn’t handle one thing first.
This is hard for me to say. Because honestly, I love to sing the praises of index investing, preach about the importance of minimizing your investment costs, and laud the simple power of diversification. I tend to nerd out when it comes to those simple ways that you can cut through a lot of the investing BS out there and get your fair share of returns without all the stress and hassle.
But the truth is that all of that focus on returns is much ado about pretty much nothing. Because for the first DECADE of you investment life, the returns you earn, good or bad, barely matter at all.
There’s only one thing that really matters, and the good news is that it’s the one thing you’re in complete control over.
Your savings rate.
The power of saving
It’s hard to really appreciate just how powerful it is to save more money without a visual. So let’s make one!
We’re going to compare two people, Frank and Sarah. Both of them make $75,000 per year and are ready to start saving for financial independence, but they go about it in different ways.
Frank frees up enough room in his budget to save 5% of his income. He also spends a lot of time reading up on the finer points of investing, creates a smart investment strategy, and is lucky enough to live through one of the good periods for the stock market. All of that gets him a 10% annual return from his investments. (Note: This is VERY high. 7-8% from the stock market is likely a more reasonable expectation.)
Sarah takes NO time to learn anything about investing. In fact, she just puts all of her money into a savings account at the local big bank which earns her a big fat 0% return. Maybe not the best move in the world, BUT she also finds enough room in her budget to save 10% of her income.
So we have Frank, saving 5% of his income and earning 10% returns. And we have Sarah, saving 10% of her income and earning 0% returns.
Who does better? Here’s the chart:
Remember, Frank is earning 10% returns every single year, which is probably way more than any of us should expect. Sarah is earning nothing.
And it still takes 14 YEARS(!!!) before Frank’s incredible returns are able to overcome Sarah’s savings rate. Sarah ends each of the first 13 years with more money.
THAT is the power of saving.
How quickly can you reach financial independence?
One more chart for you. This one comes courtesy of this excellent post from Mr. Money Mustache, and once again shows just how powerful even a small increase in your savings rate can be:
That math works no matter what your income is. And it assumes you’re starting from $0, so if you already have something saved you may be able to get there even sooner.
It’s pretty simple really: the higher your savings rate, the quicker your path to financial independence.
Stop stressing. Start Saving.
None of this is to say that you shouldn’t spend at least a little time figuring out how to invest properly. There are some easy ways to make sure that you maximize your potential returns, and it’s a good idea to take advantage of them. Every little bit helps.
But the moral of the story is this: if you want to reach financial independence sooner, STOP worrying about how to get better returns and START figuring out how to save more money.
It’s as simple as that.
Want more detail on how to actually invest all that money you’re saving? Here it is: The Only 7 Investment Decisions That Matter.