One of the potential pitfalls of reading about any activity is that the act of reading could potentially replace the much more important act of doing the activity. This is a concern that primarily crops up in the field of health and fitness—the act of regularly reading about dieting, lifting weights, and running could actually displace the act of dieting, lifting weights, and running because the fulfillment created by reading about something can actually occupy some of the mental space that would otherwise receive fulfillment by performing the act itself.
That concern could extend to finances as well—if you read about stocks and bonds all day, that could replace the act of actually generating the capital you need to make successful investments.
This brings me to one of the most important truths about investing: your savings rate is almost assuredly more important than the rate you earn on stocks.
Allow me two examples to illustrate:
Jack’s goal is to eventually create a portfolio worth $1,000,000, which he figures he could turn into a $40,000 income stream. He gives himself 35 years to do this, and figures that he can earn 10% annually by following the markets closely. In order to succeed, he is going to have to save $265 per month over the course of that time, which would work out to saving $8.83 per day.
But let’s say you have the same goal, but are a less talented investor: you want to save $1,000,000 within 35 years, but you can only earn 7% over the course of that time. Simply clicking the “reinvest dividends” button on stocks that do not go bankrupt would be enough to accomplish that feat. What would you have to save per month to get there? You’d have to save slightly over $555 per month to get there. That works out $18.50 per day.
This is why doing can be more important than reading. Everyone and their mother can get 7% annual returns if they avoid stupidity (only buy companies that have grown profits in at least 11 of the past 15 years, and avoid selling low), but 10% annual returns going forward is something that requires decent acumen. To end in the same place, you get to decide: is it easier to try and spend your time mastering investing, or would it be easier to find a way to save an extra $290 per month? Because if you can save that extra $290 per month, you’ll achieve the same end result 35 years from now as the guy who earns 10% annually over that course of time. You know yourself better than I do, and it’s your money—you get to make that decision for yourself.
Ideally, you should try to reach a point where a guaranteed savings rate is understood, and you spend your time focusing on making capital allocation decisions rather than reshuffling assets. If you own a property that pays out $1,000 per month in rental income for you to allocate, or you have $1,000 worth of energy MLP income coming in each month, then you can’t help but get wealth—you are spending each month finding ways to increase your annual income by $30-$50, which will then pay out its own dividends, interest, and rent that will grow over time so that you’ll have even more money to allocate each subsequent month compared to the last. At that point, you have the infrastructure for success.
The hierarchy of your investing priority shouldn’t necessarily be focusing on finding stocks that grow at 12%+ per year.
Instead, it could be something like this:
(1) Focus on increasing your savings rate.
(2) Lay the infrastructure to get $300+ in passive income per month, whether it be interest, rental, distribution, or dividend income.
(3) Then, begin to focus on being a capital allocator, using each month to buy new cash-generating assets that will get absorbed into your existing portfolio to give you even more money each month.
The key is to avoid paralysis. You don’t want to get into a complacent routine where you read about finance regularly, setting aside $150 each month without thinking about it. Things are more fun when you constantly keep your mind active, looking for ways to boost your monthly savings rate to $300 so you can buy brand new (or even more of the same) cash-generating assets that will allow you to have a powerhouse infrastructure that spins off income organically so that you can get rich in spite of yourself, even if you develop lazy habits (if you have $1,000 to locate towards new investments each month, and you decently diversify, it becomes almost difficult to screw up as long as selling low remains foreign to your vocabulary). The point is to avoid falling into the trap of forgetting that doing is just as important as reading.
Originally posted 2013-10-12 17:25:26.