Many investors vested in the various financial markets have a short-term mentality for gain’s and losses — geared towards a week, a month, a quarter, a year, or maybe a few years. This pales in comparison to long-term periods of 30 to 40 years. You can guess where i am coming from now. From now to retirement age, that half a percent extra on an annum basis might make or break the eventuality of living off your portfolio.
How did my portfolio compare to the benchmarks THIS YEAR? What did Equities do THIS YEAR? How did the S&P 500 fare THIS YEAR? It’s all about the short-term.
We often head to the grocers for our weekly shopping. Say your spend for this week is $201 instead of $200. Or you buy a new car for $201,000 instead of $200,000. The differential cost that we see here is not large. However, when we actually apply this same concept to investing, a difference in 0.50% per annum does make a HUGE difference when we factor in power of compounding over a long period of time.
We will use facts later to justify, but take my words for now. Do you know that the opportunity cost for this small 0.50% differential interest rate per annum would equals almost as much money to 40 years of capital contributions?
Imagine Sam, a young adult age 25 who has a 40 years time-frame for investment till he retires at 65. He injects a very modest $5,000 capital per annum into his portfolio.
$5,000 yearly capital injection, at 7% compounded growth
$5,000 yearly capital injection, at 7.5% compounded growth
A portfolio at 7% per annum compounded growth ends off with $1,142,920 dollars At 7.5%, the same portfolio ends off with $1,311,724 dollars. The difference? A cool $168,804 (or 12.9% more) which may or may not be in your pocket.
Fast forward to age 65, Sam is now retired. He draws down $75,000 yearly while his portfolio still earns 7% per annum. The estimated portfolio size remaining after 20 years at age 85 is $1,132,851. If he draws down instead $85,000 yearly (higher amount) from a portfolio which is otherwise 7.5% per annum (higher compounded interest), the estimated portfolio size is instead $1,615,043 after 20 years.
We once more fast forward to Sam at age 90, who revealed that he had actually done this investment all these years for estate planning purposes and has not touched a single cent for 65 years. At 90 years old, the 7% portfolio would be worth $6,203,121 while the 7.5% portfolio, $7,999,338. A good difference of about $1.8 million!
While internalising the concept for a half percent difference in return when investing, it is also prudent to invest in investment instruments that you understand and able to stomach the risk appetite. It is also rationale to expect a realistic return from the investment instrument vested or the diversified investment portfolio put together.
Is a 0.50% difference too ‘little’ for you?
Theory of Constraints 