Last week, we introduced the 80/20 Rule: The principle that says for just about any event, 80% of effects are caused by 20% of causes. When applied, this rule can give you immense leverage. This week, we’re looking at how the 3 keys to a strong portfolio can help you leverage your money and time for greater savings now and in retirement.
Here’s a hard reality: even smart, hard-working people like you who spend 40+ hours a week for thirty or forty years at a job that pays well cannot work their way to riches! There might have been a time when a pension would help you live comfortably, but it certainly wouldn’t make you rich – and now pensions have all but disappeared. For many of us, the 80/20 Principle is working backwards: 80% of our work and related income yields 20% or (even less) of our retirement and discretionary money, since the rest of it goes toward necessary living expenses – instead of 20% of our work and related income producing 80% of our retirement and discretionary money. There are plenty of online retirement calculators that show you how much you’ll need to save and successfully invest every month to live at only 50% or 60% of your current income, and the amounts can be staggering – particularly if you’re over 40 and have some catch-up to do.
Some think that an obvious way to “80/20” your finances would be to whittle away at the small stuff like your Starbucks coffee or health club membership – maybe get rid of the 20% of stuff you don’t need. This might save you a few bucks here and there, but it in no way follows the 80/20 concept of creating exponential results! (In fact, this can easily lead to a sense of deprivation, which sets a whole other psychological trip in motion!)
Others suggest that you should save 20% of your income. While this isn’t a bad idea in theory, there’s much more to creating wealth than just stashing 20% of your earnings under your mattress (aka in a standard low-interest savings account).
Let’s set this not-totally-unhelpful-but-still-limited thinking aside and focus on the larger picture. Instead of asking the question of what small things you think you should give up, let’s identify the 20% that will create the most wealth with the least effort, using financial tools and resources that are already set up to grow your money.
1. Look for low volatility and consistent returns.
The best way that I know to “80/20” your money is to invest in a low-volatility investment with consistent net returns and compound interest. Compound investing, in and of itself, is THE “vital 20%” of leveraging our finances. No big bells or whistles – just smart investing.
Good ole’ index funds, blue chips, and low-fee mutual funds that track the market are familiar ways to invest your money, but there’s a lot of volatility (ups and downs) that can literally rob your portfolio’s return every time the market takes a dip. For example, in the chart below, you can see that if you had invested $100,000 in the S&P 500 forty years ago (which produces an average annual return of just over 10%), you’d have about $3.8M today – not a bad investment! But, if you had invested the same $100,000 in an account with a 10% consistent net return, you’d have about $6M – $2.2M more! (Your reward for being smart enough to choose consistency over volatility.)
It’s interesting that the two investment methods share a similar overall average return, but without the consistency that produces a steady upward climb in income, you lose a lot of money and opportunity cost along the way that is extremely difficult to recuperate.
2. Make timing a non-issue.
There’s more to consistency than just the superior return. So, let’s take our 80/20 thought process a step further to consider the aspect of timing — which I think we can all agree is so important in life — and look at how we can not only avoid a potential loss due to poor timing but how we could make it a non-issue altogether.
As you exit the work force and rely more heavily on the investments you have made throughout your lifetime to provide retirement income, timing becomes crucial. If you’re invested in assets with a lot of volatility like the stock market, you could be in a world of hurt during a market downturn. If there is a giant correction in the stock market and you don’t have the time and financial resources to ride out the economic storm, it could become a very dramatic scenario for you and your family.
We need to recognize that, even more important than earning the additional money, as in our example above, a consistent return can be a lifesaver when it comes to timing. When you are nearing retirement age and are fully dependent on the continual success of your investments as necessary income, are you willing to even chance having a big loss?
There could come a point when you’ll no longer be able to recover from a bad outcome due to volatility in your portfolio, so why even risk it? A consistent return can bring peace of mind and reassurance that you will be able to support yourself and your family throughout retirement, regardless of the whims of the volatile stock market.
3. Choose investments that are recession resistant.
Protect yourself by making sure you understand what a downturn will look like for the investments in your portfolio. When the recession economy returns (which we all know is just a question of when, not if), things are likely to go a lot more smoothly from both mental and financial perspectives if you first invest a little time learning how your investments are likely to perform.
In addition to looking for investments that have consistent net returns and no volatility, your best bet is to seek out investments that are not correlated to the whims of the market and that have principal protection. Hughes Capital’s buy and hold fund is an example of this type of non-traditional investment that is not correlated to Wall Street.
If I have learned anything in the last 10 years, it’s that my portfolio needs to be prepared for that downturn. I am 10 years older which means I have 10 years less to recover.
Next week, I’ll explain 3 more ways to 80/20 your money, including demonstrating how 20 hours of your time could bring you $666,323 in profit.