Wednesday, October 29, 2014

Why extreme savings is more powerful than investing

Very often, I receive a lot of emails from readers on how they should start investing. Somewhere and somehow, I suppose many of them heard that investing is important or investing can actually be an answer to a better life. This kind of question on how should I start investing was a question I asked myself a few years back. It was because I asked myself this question that gave me a clearer understanding of what investing is really about.



The myth of investment returns

Investing early is important as your money gets compounded over time. However, investing too early without sufficient capital will only yield a little return. Let's say you have a $5000 savings that you want to invest. If you're lucky enough to get a 10% return every year for the next 5 years, your capital will only grow to $8052.55. This is not going to make you rich in any way even if you had invested it for 20 years. Mind you we're talking about 10% return on investment here. On the other hand if you focused on saving money say $1000 per month, your money grows at an astonishing $12,000 per year. Invest this savings at a 8% return and you would have accumulated $100,000 in just 6 years. If you started saving this $1000 per month at the age of 24 and invest consistently, you would be worth a million dollars by the time you're 50.

Let's review the numbers again. $1000 saved every month and invested at a 8% return will make you a millionaire by age 50 if you start at age 24. At 8% return, it takes only 9 years for your money to double (72÷8). This is the rule of 72.

There will be people who will tell you that you can turn $1000 into $10000 in just a few weeks or even days trading Forex, Options, Futures etc. To me, that's just not realistic at all. From $1000 to $10000 is a crazy 1000% return. If you do not have enough money, quit thinking of using that little money you have and think that you can make a lot of money with it. It's just too much risk and you can lose everything and even more if you're trading using those leveraged products.

Let's face it. Investment returns depends on the market. You cannot and don't have the power to demand any returns from the market. If you're lucky, you get more than 10%. Not so lucky you get 5%. If you're unlucky, you get less than 2% or worse still you lose your hard earned money. Throughout history, the average returns for the average person is about 5-8%. Dreaming of a 20% return every year for the next 20 years is almost impossible. The reality is, investment returns are not as high as we thought it would be. On the other hand, savings is completely predictable and can be controlled by us. You decide where you spend that money on, you can try to earn more money. There's a certain level of control there.


Savings before investment

Your savings play a vital role in your accumulation of wealth. Retiring a millionaire is not a dream if we plan it correctly. Save $1000 per month at 8% return will give you 1 million dollars in 27 years. Save only $200 and you would require a 18% return to achieve the same 1 million dollars. It is very hard to achieve 18% return on investment for a long period of time.

If you manage to bump up your savings to $2000 per month and invest it at the same 8% return, then you would be able to achieve a million dollars in 20 years. This means if you start at the age of 25, you would become a millionaire by the age of 45. Savings is important. Investing is also important. Savings is the basic foundation in financial planning. Get the foundation right and your financial future is on the right track. Start saving first while you look at ways to increaseyour income. Focusing on only increasing your income is just one sided. Go for both increasing your income and start a savings plan at the same time.


P.S: Found out about a site ShopBack that gives you coupon codes and offers, on top of cashback. This allows you to save more when you shop. You can find merchants like Taobao, Aliexpress, Lazada and more on ShopBack.  You can even find groceries deals and offers too, with merchants like RedMart. (Updated in Jan 2016)


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Related Posts:
1. Save 75% of your income to retire in 7 years
2. Why it is hard for most Singaporeans to retire early?

11 comments:

  1. Hi SGYI,

    Savings are generally underestimated and being able to double/triple your savings rate is more powerful than doubling/tripling investment returns when a person is just starting out!

    The comparison can be found in this link:

    http://www.my15hourworkweek.com/2013/09/08/aladdins-choice-superior-saving-rate-or-superior-investment-return/

    ReplyDelete
    Replies
    1. Hi 15HWW,

      I agree. For young people just starting out, we need to build a base first. A strong base (savings) will make our investing journey more stable. Will it? That'll still depend on whether we build up correctly or not.

      Delete
    2. Hi SGYI,

      May I know which kind of investment with 8% of return? I'm keen on invest but not sure where to start.

      Delete
    3. Hi Andrew,

      Getting 8% return depends on individual's investment portfolio performance. Investing in stocks can yield 8% for some while not for others. We have to learn as much as we can and know how to analyse businesses. I've written a few articles on investing on the right side bar of my blog. You can read it in your free time :)

      Delete
  2. Very true! Keep the good stuff coming...

    ReplyDelete
  3. Where can u find savings plan which gives u an 8% interest then?

    ReplyDelete
    Replies
    1. Hi Muzlifah,

      There is no savings plan which gives 8% from the bank. We have to invest it .

      Delete
  4. This comment has been removed by the author.

    ReplyDelete
    Replies
    1. Hi Daryl,

      When we save money, a portion of it goes into investments if we do invest at all. For me, i would set aside an emergency fund (6-9 months of my income) in a savings account and not use it for investment at all. All the other savings can be invested. Of course, i don't invest fully at once but buy in portions. I can be 80% in cash now and 20% in cash the next few years. It depends on the market on how much i want to invest. But, all these money are my investment capital which is separated from the emergency fund i set aside. Hope this clarifies :)

      Delete
  5. I see there is some inconsistencies in your article. "You have $5000 that you want to invest is completely different from you are able to save $1000 a month" one is a stock and one is a flow. And strictly speaking both are your own money, investment gains are the real money growth.

    Later on, you went on saying about investing the savings, which is then correct and I completely agree with you. The key is not to let your money stay in the bank or at your house to collect dirt. :)

    ReplyDelete
    Replies
    1. Hi Yong,

      The first part of the equation before investing is always savings. The more we save, the more capital we have to invest. The last thing we want is to depend entirely on investing to grow our money when in fact, savings is imoortant also. We have to balance the 2 approaches.

      Delete