New Year’s Resolution: Spend Less, Save More

Jorge A. BetancourtUncategorized

The perfect time to achieve financial success is now. The New Year often reminds us of things about ourselves that we should improve to build a more quality life for the future. Becoming more financially successful should be at the top of almost everyone’s list. This article will give you a better idea of why you should make financial success your New Year’s Resolution, and how to go about achieving your financial goals.

Begin Investing As Soon As Possible

For young people, especially, it is easy to put off saving and investing until one feels more financially stable. But due to the power of compound interest, which Albert Einstein called the “eight wonder of the world”, even a tiny amount of investing today will go a long way in building future wealth. The chart below shows an example of three different investors who chose three different financial strategies. Let’s compare Susan and Bill first. Susan started investing 10 years before Bill, and invested $100,000 less than him over their entire lifetimes. Yet, Susan ended up with more money for retirement because the money she invested was compounded 10 years longer. Investing early often matters more than how much you invest. Chris started investing when Susan did but continued investing every year until retirement. He not only started early, but invested often. Chris became a millionaire in this scenario by simply investing $5,000 a year.

chart-jp-morgan-retiremen

Passive Investing Rather Than Active Investing

Most people have heard of the phrase “buy and hold”. Other than being a recognizable phrase, this strategy involves limited buying and selling activity and require less maintenance, with investment positions designed to capitalize on prospects for long-term capital appreciation. After starting a retirement account, many people have the urge to move in and out of investments over short periods of time. Usually they are responding to short-term market movements. When the market drops, their fear takes over and encourages them to sell. When the market goes up, their greed takes over and encourages them to buy. This can be a recipe for disaster and can leave you with a lot less money than you would have otherwise had using a passive strategy.

A Buy and Hold passive investment strategy is most effective when coupled with a Rebalancing strategy. Rebalancing is the act of periodically realigning the allocation of your portfolio. For example, let’s assume you have a portfolio allocated in 70% stocks and 30% bonds. Let’s also assume that stocks have outperformed bonds over the past year. Because the value of stocks has grown faster than the value of bonds, the value of the stocks in your portfolio now makes up more than 70%. The higher percentage of stocks in your portfolio raises the risk of losses because stocks are usually riskier than bonds. In this case, you should sell stocks and buy bonds to get your allocation back to 70/30. If the price of bonds rises more than the price of stocks, sell bonds and buy stocks. You should not rebalance very often. Depending of your risk tolerance and volatility of your portfolio, rebalancing frequency could be different between individual investors.

Exchange-Traded Funds (ETFs) are the perfect instrument to help you implement the Buy and Hold with Rebalancing strategy. In a study done by S&P Dow Jones Indices, researchers discovered that 86% of actively managed equity (stock) funds underperformed the market. You can get around this problem by buying passively managed ETFs. ETFs are similar to Mutual Funds, except Mutual Funds are actively managed and ETFs are passively managed. Holding an ETF in your portfolio is by far less expensive than holding a Mutual Fund. This is important because you cannot control the stock market returns but you can control your fees.

Diversification

One of the most important concepts that will improve your financial success is diversification. This concept is important because it will protect you from major losses should one of your assets rapidly deteriorate in value. The idea is to allocate your money across many different asset classes (e.g. stocks, bonds, commodities, cash, etc.) so that if one asset class performs poorly it will not drag your entire portfolio down. You will be able to find a wide variety of ETFs that will give you great diversification at a low cost.
It is more appropriate for younger investors to have most of their portfolio in aggressive investments such as stocks, and older investors should have most of their portfolio in safer investments such as bonds and cash. A rather simple rule is to have the percentage of your portfolio in bonds equal your age. For example, if you are 25 years old, you should have 25% of your portfolio in bonds. Again, once you figure out how your portfolio should be allocated, you should buy and hold those investments for the long-run and reevaluate your portfolio allocation from time to time to see if rebalancing is need it.

Conclusion

Take these tips and apply them as soon as possible. The faster you start saving and investing, the more money you will make over time. Remember that you don’t need a lot of money to start improving your financial success. A small amount now will go a long way in the future. Make this year, the one that you changed your financial future for the better.