STICK-TO-ITIVENESS: A SIMPLE FORMULA FOR LONG-TERM WEALTH CREATION

Having spent around two decades of my career in finance and markets, I found myself reflecting on the most common questions I get from individuals when revealing my profession.

They generally fall into the following categories: a question on my view on a particular stock that the individual owns, a request for a “stock tip” or a view on some upcoming macroeconomic data point.

The purpose of this article is not to go over my responses to these questions, but rather to emphasize the question I believe I should be asked, namely, “What is the most robust path to long-term wealth creation?”

A simple answer to a complicated question

The answer to this question is surprisingly simple, so straightforward as to be viewed by most as a mere statement of the obvious: Start investing as soon as possible.

The reason this works is that the power of compounding is immense and the earlier one starts investing, the more years of compounding your investable assets enjoy.

How best to do this has been extensively covered by others, so here is a high-level overview: look at your income and expenses (your budget), set aside appropriate funds for an emergency or rainy day, and invest the surplus.

The challenge is in the execution

The focus of this piece is the part that is not talked about as much but is as important: once you have your investment plan in place, stick to it!

There will be fluctuations in your portfolio. Volatility is a feature of markets, not a bug, so you should expect it.

The key is to avoid getting distracted by short-term fluctuations and instead focus on the long term. After all, you will only need to draw on these assets when you eventually retire.

The importance of this “stick-to-itiveness” cannot be overstated. You may be surprised to learn, however, that several natural human biases can cause investors to stray off course and therefore underperform the markets in which they invest. Understanding these biases can help you avoid some of the most common investment mistakes.

An analysis of historical market returns data leads to some surprising insights

Due to these biases, it is a lot more difficult for us to stick to a plan, be it investment or otherwise, if the early results are disappointing. But does performance early in one’s investing journey actually make a difference in the long run?

To find out, I examined stock market returns over the past five decades. I attempted to see how much it mattered at retirement (i.e., where an investor “ends up”) whether an investor happened to begin investing at a time when near-term returns were favourable or poor (i.e., where an investor “started off”).

I will go into these conclusions in more detail below, but essentially, given the long-term length of the investment period, not only did it not matter how an investor started off, they actually benefitted from having the poorer return in the earlier part of the investing journey as opposed to the later part.

Conclusion 1:?Over the period examined, there was essentially no significant positive relationship between 5-year (short-term) returns and 30-year (long-term) returns. In other words, how you “started off” did little to indicate how you would “end up” in terms of wealth accumulation.

Conclusion 2:?Overlapping a typical savings/investing cycle on the above analysis, an investor*?benefitted from having weaker initial returns, as this had the effect of their annual contributions occurring at lower index levels, and then benefiting from a greater rate of growth at the back end of the investment period.

When comparing the results, despite Investor A enjoying compound annualized returns of over 20% in the first five years against the 2% level enjoyed by Investor B, on retirement Investor B ended up with the larger portfolio, both in nominal and inflation-adjusted terms.

Turning insights to actions

Clearly, none of us knows, nor can control, future asset price returns.

What we do have control over is our own actions. Implementing an investment plan as soon as possible,?and sticking to it, is well within our capabilities, and hopefully this analysis makes it that much easier for investors to stick to their plan when times get tough.

When it comes to investment returns, what matters little is where one starts off, and what matters most is where one ends up.?

The tale of two investors

Investor A is fortunate(?) to experience a strong market in their first five years of investing; a 5-year CAGR of 22.6%. Given the early successes, it is easy to stick to their investment plan. Investor B is unfortunate(?) to experience a weak market in their first five years of investing; a 5-year CAGR of 2.0% (at a time when inflation averaged near double digits!). Given the early disappointment, it is challenging to stick to their investment plan, however if they did, at retirement they ended up with a portfolio one-third larger than “lucky” Investor A.

When comparing the results, despite Investor A enjoying compound annualized returns of over 20% in the first five years against the 2% level enjoyed by Investor B, on retirement Investor B ended up with the larger portfolio, both in nominal and inflation-adjusted terms.

Turning insights to actions

Clearly, none of us knows, nor can control, future asset price returns.

What we do have control over is our own actions. Implementing an investment plan as soon as possible,?and sticking to it, is well within our capabilities, and hopefully this analysis makes it that much easier for investors to stick to their plan when times get tough.

When it comes to investment returns, what matters little is where one starts off, and what matters most is where one ends up.

I welcome the opportunity to discuss your investment needs.

Book an introductory virtual meeting?with me and we can embark on a plan to help you achieve your financial goals.

Warren Goldblum

The information contained herein is for general information purposes only and is not intended to provide financial, legal, accounting or tax advice to be relied on without an individual first consulting with their financial advisor to ensure the information is appropriate for their individual circumstances.

*?I have picked two comparable 30-year periods in the data with the same levels of annualized returns, the only difference being the quantum of the initial returns in the period (i.e., the initial 5-year returns). I assumed a 35-year-old investor (i.e., 30 years to retirement), an opening portfolio of $100k and typical savings patterns (i.e., c.$12k savings in the first 10 years, followed by c.$9k in the following 10 years, then zero savings thereafter, in line with individual savings rates as per Statistics Canada data).

Source: Statistics Canada. Table 36-10-0587-01 Distributions of household economic accounts, income, consumption and saving, by characteristic, annual (x 1,000,000)?