A lot of people that just started investing their spare cash wonder how to make more out of their money. How they can make higher returns. I’m in that same categorie. But it really doesn’t matter that much what your returns are in the first year or two. It is way more important to focus all of your energy on just saving more. Here is why:
Return is the growth of your money. These are all cashflows and capital gains combined, divided by the average amount that is invested. Say, you invest € 100 in a share, it pays € 3 in dividends, and after a year your share is worth € 102, you have made a 5% return on your investment (3 + (102-100) / 100).
Of course, the goal of any investor will eventually be getting higher and higher returns. Your net worth grows faster with higher returns and thanks to compound interest that will really set you up for life.
However, in my opinion, people should not focus on getting better returns when they are just starting out. Instead, focus on saving more. That’s a better use of your time and energy.
Size Does Matter
When we’re talking about investing of course. When you start investing, chances are that you don’t have a lot of capital. That means, that how much return you will make, your return in absolute amounts will not be that much.
Lets say you start investing and you are able to put in € 4,000 a year. Your portfolio is inefficient (yields 4%) and expensive (total expense ratio of 0,7%). You will make a return of just 3,3%. Not bad, but certainly not amazing. Your return will be € 132 in the first year.
Perhaps you have some spare time. You use that time to research investments, look for more optimised ETFs for your portfolio. After hours and hours of research you come up with a way better portfolio. One that yields on average a 7% return and costs only 0.25% in total expense ratio.
Now your returns, on the same investment, are 6,75%, or an amazing € 270. You just spend hours and hours to earn an extra € 138. Now of course I see that in the long run this will pay off, but bear with me. For starters, it’s better to not worry much about investing (just do it!) but instead focus that time and energy on saving more.
When you are just starting out with your investments, hopefully you are still young and just started your career. If so, kudos to you! As a young professional there’s a lot to learn. Your salary will rise fast in the first few years, at least for a lot of professions. Also, there will be opportunities to make a bit of money on the side.
These things offer an opportunity to earn more income. That income can then be applied directly to your investments. So even though your portfolio just isn’t making outsized returns, it grows and grows because you are putting in more money and as a bonus get a modest return.
Then on the cost side of the equation there’s a lot to optimise as well. How easy would it be to save an additional € 10 per month from your spending? Should be super easy right? Even € 20 should not be a problem for most. Congratulations! You just saved more than the extra returns on your investment would have yielded!
In The End, Optimise Everything
Eventually, you will have to optimise your portfolio, don’t get me wrong about that. But when just starting out, it might be wise to just get into the habit of optimising your savings.
This habit is one that is hard to kill later, and will help you grow your wealth over time. Then, start optimising your portfolio. Just don’t overdo it. Invest in low cost index funds or ETFs. Use a discount broker. Invest as soon as you receive funds, presumably every month, and never sell. That will be the most optimal strategy most people can have.
For most optimisers, this will be easy. But don’t get too dep into it. Focus on earning more, spending less, investing the difference. Rinse and repeat.