The Overwhelming Importance of Your Investments

How well you invest the assets in your retirement savings buckets is important to your retirement security. Very important. Immensely so.

There’s two reasons for that. One is that investing is within your control. It’s one of only two main dials you have any significant control over. (Your other big dial is where you draw the line between spending and saving.) To be sure you’ve got lots of little dials, switches and levers you can tweak—selecting your savings bucket, asset location, spigot planning, and the like—but they are small in comparison to the investment decisions you make. (Which is not to say they should be ignored. Lots of smart little decisions can add up to big results, as illustrated in February 17’s post.)

So much of the rest is out of your control. How much will your employer contribute to your retirement? Will Social Security still be around when you retire? What’s the price of an annuity? What is inflation doing to your standard of living? Will you face a costly medical emergency? What is the stock market doing? All beyond your control. But how you choose to invest is something you can influence.

The second reason investing is so important is the overwhelming proportion investment returns are of your total asset-based retirement spending, compared to dollars you (and perhaps your employer) actually contribute. Which is ironic, since you have to work so hard to earn those dollars. And you have to exercise such admirable discipline to refrain from spending them on toys and candy. While that work and discipline is necessary to get the dollars into your savings bucket in the first place, time and the markets can then do the vast majority of the work. You just have to sit back and invest wisely. No further sweat involved. (Keep reading; there’s a punchline coming.)

Just how big a component of your spending are your investment returns? Surprisingly big. How about 97%? Here’s an example.

Example. Oscar starts saving for retirement at age 25—as soon as he embarks on his career (as a professional grouch) after college. Following his impeccably thought-out retirement savings plan, he saves 7.99% of his $50,000 starting salary, and then consistently saves 7.99% of his salary every year for his whole working life. Oscar earns raises every year that keep pace with inflation (of 3.05%). (The pay for being a grouch is decent; but the psychic benefits are huge.) If he retires at age 65, Oscar will set aside an aggregate of $317,835 during his 41-year saving period. Good boy, Oscar. Assume his investments earn an average of 9.61% per year prior to retirement. By the time he stops working, his retirement savings account will be worth $2,409,563. Oscar then implements a rational retirement spending plan. He plans to spend 6% of his retirement account each year during retirement, ratably increasing that percentage to 8% as he ages from 65 to 100. Assume that his investments earn 8.35% after retirement. Under that scenario, he will begin spending $144,574 per year at retirement, gradually increasing that to $307,166 per year by the time of his death—an aggregate of $8,034,965 during his 35-year retirement. His account at death will still be worth $3,853,084. That’s a total of $11,888,049, of which only $317,835, or 2.67%, is Oscar’s own contributions. Investment returns account for the rest—a total of 97.33% of Oscar’s asset-based retirement security.

So the hard part—working and sweating, saving and abstaining—accounts for just 3% of Oscar’s retirement. And the easy part—sitting back and investing wisely—accounts for 97%. Tres ironic.

And here’s the punchline: It turns out to be very hard to be a wise investor. In fact, I think there’s simply no such thing as smart investment decisions. The best you can achieve is avoiding foolish actions. So that’s what then counts for smart—the absence of foolishness. It doesn’t sound like a difficult standard, but I fear that the bar is very high indeed.