Dubai: When investing your money, you would naturally aim to put your money in investments that assure you higher profits. But you may also be aware that often times you cannot control or precisely predict how much money you make when investing, given how much the markets fluctuate.
“What often gets lost when pursuing the next best investment is the most powerful element of building wealth: saving as much money as you can in the first place,” said Zubair Shakeel, an investment advisor working with a Dubai-based asset manager.
“While you can’t entirely control the market, the cost of commissions, fees, and even the profits you make, you can, however, control your own rate of savings. And there is ample evidence that it is the initial savings, not investment gains, that determines how much you end up with over time.”
How saving more can offset abysmal market returns
The reasoning is pretty straight-forward: If you save as much as you can, you don't have to worry about getting abysmal returns on your market investments because increasing savings can eventually result in higher profit rates when investing more money later.
Here’s an example. If you invest Dh5,000 per year for 30 years and get 10 per cent annual return, the invested amount will grow to Dh900,000. However, let’s say you were to invest Dh8,000 per year for 30 years, but you only get an 8 per cent annual return and end up with around Dh978,000.
So investing an additional Dh3,000 every year (or Dh250 per month) can more than offset a 2 per cent difference in profits. Now if you were to boost your savings to up to Dh10,000 per year, you're looking at more than Dh1.2 million in the end. This is why it helps to save more now than to invest.
Can you realistically save more in order to invest more?
“If you're able to save a lot more now, you will get a greater return on your investments in the future, but that often makes logical sense only in an ideal world. So while the results can be amazing when your savings and investments grow in tandem, it’s often not always possible,” added Shakeel.
For instance, in the above examples, if you were able to boost your contributions from Dh5,000 to Dh8,000 annually while also getting that great 10 per cent return. You'd be looking at Dh1.44 million 30 years later. In other words, an additional Dh3,000 each year results in Dh500,000 more over time.
“Also, not everyone invests with ease. There is risk when you put money in markets, and everyone's tolerance for this is different. If you don't save more money up front, you may try aggressive investing strategies to make up the difference,” he added. “That can lead to bigger losses.”
Saving more now lets you invest more conservatively later
Additionally, if you save as much as you can, you can afford to be more cautious about what you invest in. This is especially true for investors who are looking to preserve their savings as they near retirement.
“It’s key to know how much you can realistically start saving now and by much you can afford to raise your savings in your current financial situation,” said Brody Dunn, an investment manager at another asset advisory firm in the UAE.
So while it’s widely recommended that you aim to save at least 15 per cent of your income each year, your personal target saving rate may vary depending on a variety of factors, including when you plan to use your savings, when you started saving, and how much you've already saved.
Start saving a manageable amount, don’t invest right away
“When you start saving, aim for an amount that's manageable. Then, challenge yourself to save 1 per cent or more each year toward retirement. While 1 per cent is a small percentage of your annual earnings, after 20 or 30 years it can make a big difference in your total savings,” added Dunn.
“The key to growing your savings is to increase your contributions each year. If your plan lets you set automatic increases every year, definitely take advantage of it. But remember, you don't have to get to the recommended 15 per cent overnight, you can change contribution amount if you need to.”
Dunn explained that the inherent problem with investing small amounts early is that if the market has a good month, your money will buy fewer shares, which implies fewer profits later. If the market has a bad month, your money will get more, but you end up losing money due to the downturn.
Key takeaways
When the topic of investing is brought up, it’s often emphasized that you are to get the most return for their money. For instance, if you were getting a 7 per cent return on their stock portfolio, you would strive to get 8 per cent, and so on.
But is pursuing higher returns worth it if your savings amount don’t rise as much? Veteran investors caution against it because while shooting for a high return is commendable, what often gets lost in this discussion is saving as much money as you can in the first place.
As mentioned earlier, if you save as much as you can, you don't have to stress as much about getting the best return on your investments. In fact, a boost in savings can often be more powerful than a higher rate of return. So save more so you can invest a higher amount later, reaping bigger profits.
