Why Investment Returns Don’t Matter (If You’re Not Saving)

Categories: Business

Financial BuildingPeople often talk about great investments they’ve made or the incredible investment return they’ve received. Making good investment decisions is an important part of growing your wealth over time. By intelligently putting your money at risk, you have the opportunity to outpace inflation and increase your wealth. It takes some of the emphasis off of saving and puts more importance on smart investment choices.

But are saving and investing really two separate actions?

Taking No Action Yields No Results

The act of saving is completely different than the act of investing. Saving simply means setting aside money that will be used later on, while investing means choosing to put your money at risk for the opportunity to generate a return on your investment (ROI).

With investing comes the risk of loss and that can be scary, especially for someone who doesn’t understand how much to invest or what to invest in. It may feel like there’s no room for error, because if you get it wrong you risk losing your money.

And that’s the dilemma. Many people choose not to save anything because they don’t know what to invest in. They claim that they don’t know what they’re doing, and therefore, don’t even save money – let alone invest it.

This is also known as analysis paralysis. This is the state of over-analyzing or over-thinking a situation to the point that you never make a decision, or take action. And doing nothing is often worse than getting it “wrong.”

Understanding the Power of Saving

Here’s the deal: positive or negative investment returns don’t matter much if you don’t have money saved to invest.  7% return on $0 is always going to be $0.

Let’s say you invest $10,000 on January 1 of this year. You then receive a 7% return on that money over the next 12 months. You now have $10,700 in your account. You saved $10,000 and you earned $700.

Most of the increase in the account over the year came from you saving $10,000. The $700 is only a small portion. Which is to say that the investment return, although nice to have, didn’t really impact your account all that much.

Now, let’s say you’ve done a great job saving over your lifetime and you now have $1,000,000 to invest. Again, you invest that money on January 1 and you earn 7% over the next 12 months. By the end of the year you have $1,070,000 in your account. The investment return was $70,000.

That’s a lot more than your annual savings of $10,000. In fact, that’s 600% more.

Not saving because you don’t know how to invest is like trying to run a marathon after intentionally shooting yourself in the foot. Don’t compartmentalize saving and investing.  Saving and investing are two separate things – but they work best when combined.

Make Saving and Investing Work for You

When you put the emphasis on saving so that you do have something to invest, you have the opportunity to take advantage of compound returns over time. Remember, the returns don’t matter all that much early on, so don’t worry about them to the point that you aren’t taking any action with saving at all.

The best way to financial success is to simply start today.

This article was first published in Forbes.com and was written Eric Roberge, CFP®  the founder of Beyond Your Hammock, a virtual fee-only financial planning company.

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