If you want to grow your wealth, you need to save money and invest. But where should you focus more? This article explains why your savings rate is more crucial than your rate of return.
When you start saving for financial independence, your savings rate is key. Sure, a high rate of return is exciting, but it shouldn’t be your main focus. Once you have a substantial amount saved, then your rate of return becomes more relevant.
You should prioritize saving over worrying about returns because you can’t control your returns. Investments come with risks that can affect your returns, so it’s essential to always consider risk.
To illustrate, let’s talk about my friend Dave. Dave is really into cryptocurrencies and checks his portfolio daily. He invested $1,000 when the market was low, and now his portfolio is worth $1,500 in a year—a 50% increase. Impressive, right?
Dave and I often discuss early retirement and saving most of our income. While he’s very interested in personal finance, he spends his paycheck on new shoes, clothes, an Xbox, and a MacBook. He sets aside $80 per month for his crypto investments, which grew to $1,500 in a year.
Dave believes his crypto returns will help him retire by 45. While a 50% return in one year is great, it’s not enough to rely on for early retirement. He needs a more realistic plan because $1,500 isn’t going to cut it for anyone.
To build wealth, you need thousands of dollars saved. This means saving a large portion of your income to grow your savings and investment accounts.
New investors often chase big returns because they seem like “free money.” But at the start of your investment journey, focusing on big returns isn’t practical. For example, if you have $1,000 invested, a 50% return only gives you $500. But if you save 50% of your income and have $10,000 in the bank, a 5% return would yield the same $500.
It’s crucial to build your investment portfolio first. Once it’s substantial, your rate of return will have a more significant impact.
Compounding interest is amazing. It means your returns also generate returns. For example, if you double $10 every day for two weeks, you end up with $81,920. But early on, compounding doesn’t have much effect. $20 becomes $40, and that’s it. Most growth happens when there’s already a significant amount saved.
So, focus on your savings rate at the beginning. It’s the one number you can control. Save as much as possible to reach those big numbers faster. This approach is how I aim for financial independence.
To calculate your savings rate, divide the amount saved by your net income. Set up a budget that suits you. A budget isn’t restrictive; it’s a way to prioritize what’s important. Saving money can be fun and exciting! If budgeting isn’t your thing, just pay yourself first.
Besides saving more, you can also earn more. Consistent raises in your career can have a compounding effect. Not sure how to get a raise? I’ve got tips and tricks that helped me get a 20% raise in one year.
Focus on things you can control. Early on, prioritize saving to build your nest egg. You can do side hustles in addition to your day job.
As you progress, give more importance to investments. Do your research and protect your investments from losses. As you grow your money, you’ll become more sensible with your investment choices.
Invest to maximize and reach your financial goals over time. With a secure savings rate, you can afford to take some investment risks.
Your savings rate is under your control, but your rate of return isn’t. Even with peer-to-peer lending, once your money is invested, it’s out of your hands.
A 50% return on a small amount won’t significantly impact your retirement path. But a 10% return on $300,000 will. That’s why your savings rate is more important, especially at the beginning.
Think of building your wealth like building a house. Your savings are the foundation—strong, solid, and stable. From there, you can build up with investments. This approach helps you handle any financial challenges that come your way.
Do you focus on your savings rate or your rate of return?